Peregrine Foundations of Business Finance Practice Test

The price-to-earnings (P/E) ratio is a key financial metric used to evaluate the valuation of a company's stock. It is calculated by dividing the market price per share by the earnings per share (EPS). This ratio provides investors with insight into how much they are willing to pay for each dollar of earnings generated by the company.

A higher P/E ratio may indicate that investors expect future growth, while a lower ratio might suggest that the stock is undervalued or that the company is experiencing difficulties. By focusing on the relationship between the stock price and its earnings, the P/E ratio helps investors assess whether a stock is a good investment relative to its earnings potential.

The other choices do not accurately reflect the method for calculating the P/E ratio. For instance, dividing total revenue by the market price per share does not provide insight into profitability, while using earnings per share in the numerator instead of the denominator misrepresents the relationship being measured. Similarly, the ratio of total assets to total liabilities relates to financial leverage and solvency, rather than valuation. Thus, the correct answer is clearly rooted in the proper formulation of the P/E ratio as a tool for investment analysis.