Financial Planner

Answer: D - To determine the value of stock investments that are not paying cash dividends one need to use P/E ratio. The ratio or earnings multiplier tells an investor the price being paid for each $1 of earnings. This is a major advantage of P/E ratio. The dividend discount model assumes the firm is paying or is going to pay a cash dividend. However, as a disadvantage, the P/E ratio does not tell whether a sock is overvalued or undervalued to its market price. Investors are required to draw inference to historical P/E ratios in determining if the P/E ratio is high or low. The dividend discount model allows for comparison to determine whether a stock is overvalued or undervalued to its actual price.