Question: 1. You use a valuation model to arrive at a value of $15 for a stock. The market price of the stock is $25. The

1. You use a valuation model to arrive at a value of $15 for a stock. The market price of the stock is $25. The difference may be explained by:

a. A market inefficiency; the market is overvaluing the stock.

b. The use of the wrong valuation model to value the stock.

c. Errors in the inputs to the valuation model.

d. All of the above.

2. You are estimating the price-earnings multiple to use to value Paramount Corporation by looking at the average price-earnings multiple of comparable firms. The following are the price-earnings ratios of firms in the entertainment business.

Firm PE Ratio

Disney (Walt) 22.09

Time Warner 36.00

King World Productions 14.10

0 New Line Cinema 26.70

a. What is the average PE ratio?

b. Would you use all the comparable firms in calculating the average? Why or why not?

c. What assumptions are you making when you use the industry-average PE ratio to value Paramount Corporation?

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