1.Based on the following information, choose all responses which are correct.

You are researching the valuation of the stock of a company in the food-processing industry. Suppose you intend to use the mean value of the forward P/Es for the food-processing industry stocks as the benchmark value of the multiple. This mean P/E is 18.0. The forward or expected EPS for the next year for the stock you are studying is $2.00. You calculate 18.0 $2.00 = $36, which you take to be the intrinsic value of the stock based only on the information given here. Comparing $36 with the stocks current market price of $30, you conclude the stock is undervalued.

Your conclusion may be in error because if the peer-group stocks are themselves overvalued, the mean P/E of 18 may be too high to use in valuing the stock.

Your conclusion may be in error because if the mean P/E is influenced by outliers.

Your conclusion may be in error because the stocks fundamentals may differ from those of the peer-group stocks.

Your conclusion may be in error because, comparing $30 to $36, you could plausibly conclude the stock is overvalued.

Your conclusion may be in error because if the stocks expected growth rate is lower than the mean industry growth rate, then the stock may deserve a higher P/E than the industry mean.

Your conclusion may be in error because if the stocks risk is higher than the mean for the peer-group stocks, then the stock may deserve a higher P/E than the industry mean.

Your conclusion may be in error because if the stocks expected growth rate is lower than the mean industry growth rate, then the stock may deserve a lower P/E than the industry mean.

Your conclusion may be in error because if the stocks risk is higher than the mean for the peer-group stocks, then the stock may deserve a lower P/E than the industry

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2.Based on the following information, choose all responses which are correct.

May Stewart, CFA, a retail analyst, is performing a P/E-based comparison of two hypothetical jewelry stores as of early 2009. She has the following data for Hallwhite Stores (HS) and Ruffany (RUF).

HS is priced at $44. RUF is priced at $22.50.

HS has a simple capital structure, earned $2.00 per share (basic and diluted) in 2008, and is expected to earn $2.20 (basic and diluted) in 2009.

RUF has a complex capital structure as a result of its outstanding stock options. Moreover, it had several unusual items that reduced its basic EPS in 2008 to $0.50 (versus the $0.75 that it earned in 2007).

For 2009, Stewart expects RUF to achieve net income of $30 million. RUF has 30 million shares outstanding and options outstanding for an additional 3,333,333 shares.

Because investing looks to the future, analysts often favor forward P/E when earnings forecasts are available.

HS's forward P/E = 22.0

RUF's forward P/E per diluted share = 22.5

Assuming all other factors are the same for both stocks, RUF provides the more attractive investment scenario at the moment.

HS's forward P/E = 20.0

The unusual items affecting RUF's EPS for 2008 are not relevant, so trailing P/Es should be used to compare the two companies' valuation.

Because RUF has a complex capital structure, the P/Es of the two companies must be compared using diluted EPS.

Because RUF had some unusual items affecting EPS for 2008, forward P/Es should be used to compare the two companies' valuation.

RUF's forward P/E per diluted share = 25.0

Because RUF has a complex capital structure, the P/Es of the two companies must be compared using basic EPS.

Assuming all other factors are the same for both stocks, HS provides the more attractive investment scenario at the moment.