Final answer:
The true statements about the Price/Earnings (P/E) valuation method include requiring the founder to locate the P/E ratio for similar public companies in the industry, and while it is somewhat straightforward, its application can be affected by market conditions and other metrics. Statements about multiplying or dividing the P/E ratio by earnings or cash flows to establish future sales prices are not standard practices. The correct answer is options C and D.
Step-by-step explanation:
The Price/Earnings (P/E) valuation method is a tool used in finance to determine the value of a company's stock. In assessing this method, it's important to understand which statements are true regarding the use of P/E ratios:
- C. It requires the founder to locate the P/E ratio for public companies in the same industry. This is true as the P/E ratio offers a benchmark against competitors and can help in estimating the potential value of a company.
- D. It is a straightforward system that uses the industry in which the start-up operates. This statement is partially true. While the P/E method is based on the industry and is relatively straightforward, it is also influenced by market sentiment and other financial metrics, which can complicate its application.
As for statements A and B, these are not standard practices in the application of a P/E ratio:
- A. The P/E ratio should not be multiplied by the capitalized earnings to establish a sales price in year 6; it is typically calculated using the current earnings.
- B. The P/E ratio does not involve dividing by the net cash flow for year 5 to add back as a sales price in year 6. Instead, the P/E ratio is typically applied to the earnings per share to estimate the market value per share.