Question 1: Project Evaluation (10 marks)

Part A For unconventional cash flows, there will often be multiple IRRs. Under those circumstances, we cannot use IRR for evaluation purposes. See Pitfall #2 in Berk and DeMarzo (2020, pp.251).

i) Construct a hypothetical unconventional cash flow that yields two possible IRRs. Present your cash flows in a table and plot its NPV profile. (1.0 marks)

ii) Construct a hypothetical unconventional cash flow that yields three possible IRRs. Present your cash flows in a table and plot its NPV profile. Furthermore, assess which of your two hypothetical projects (i or ii) you would rather invest in. (1.0 marks) Document your workings in the Excel Spreadsheet. (1.0 marks)

iii) Briefly explain how you would construct an unconventional cash flow in order to have k possible IRRs, where k > 1. Next, comment on the likelihood of such a cash flow occurring in real life, when k is large.

Part B

You are told that the enterprise value of a firm is equal to its market value of equity plus any net debt the company holds. In other words,

Enterprise Value (EV) = Market Value of Equity (MV) + Debt - Cash. (Net debt is debt minus cash)

Furthermore, you're told that EV is the present value of the firm's free cash flows (FCF).

FCF is essentially the total amount per annum that the firm has available to pay out to both equity holders and debt holders. FCF comes from company earnings after deducting for tax, investments and changes in net working capital. You don't need to worry too much on how FCF is derived - that's for 2nd year corporate finance.

Simpkins FCFs (year end figures) are currently projected as:

2019--1mil

2020--1.1mil

2021--1.2mil

2022--1.5mil

2023 1.55mil

Assume FCFs after 2023 will growth at 3% for the next 3 years and 2% thereafter. Assume the cost of capital (discount rate) is 10%. Net Debt is 1m. The company has 16mil shares outstanding.

i) What is the current value of Simpkins shares?

Simpkins management is considering three mutually exclusive projects that will likely impact future FCF as shown in the table below. No new debt is raised to fund these activities.

2019 2020 2021 2022 2023

A -2mil n/a 0.5mil 1mil 2mil

B -1mil constant 0.3mil pa into perpetuity

C -2mil n/a n/a 0.3mil pa in 2022 and then growing at 5%pa into perpetuity

ii) Assuming the cost of capital is still 10%, how will each project impact stock valuation? State the resulting stock price in each scenario. Ultimately which project (if any) should the company pursue? (3 marks)

Document your answers and logic in the written report. If you used Excel, show your working on a new tab.

Question 2: Risk and Return (10 marks) The 13F filings are reported by institutional investment managers to the SEC on a quarterly basis containing all US-related long equity positions. Select an equity fund manager of your choice and by using their latest 13F filing, and tabulate their portfolio weights. Do not pick a quant fund or an index fund

Hint:

You can access their latest 13F filings through the SEC EDGAR website:

https://www.sec.gov/edgar/searchedgar/companysearch.html

For example, if you picked Pershing Square Capital's, the 13F filing would be: https://www.sec.gov/Archives/edgar/data/1336528/000117266120000821/xslForm13F_X01/infotable. xml

Alternatively, you can use Whalewisdom (https://whalewisdom.com/) or a similar provider.

Once you have obtained the fund's stock picks and their weights, download the adjusted close prices from Yahoo! Finance in monthly frequency and calculate their monthly returns. You're free to use Bloomberg or any other data provider instead.

i) Describe the risk and return profiles of the selected stocks. Make sure you include analysis on the annualised mean and volatility of returns of each stock. (1 marks)

ii) Estimate the betas and subsequently the cost of equity for the stocks. Which stock has the highest systematic risk? You can assume the S&P 500 Index return is the market return and the risk free rate is 2% constant (for simplicity). If (for whatever reason) you are unable to source S&P 500 Index data, you are can use an S&P 500 ETF instead. (2 marks)

iii) Tabulate the covariance and correlation matrix in Excel, and subsequently work out the fund's total portfolio risk. (3 marks)

iv) Pretend 50% of the fund needs to be liquidated because a large client has redeemed her capital. Which stocks would you sell if you wanted to use this opportunity to reduce your total portfolio risk? Show the portfolio weights, dollar values and portfolio risk before and after the redemption.

Also show your redemption trades. (3 marks) Please document your answers in the written report and provide working out in your Excel Spreadsheet.

Question 3:

Constructing Efficient Frontiers (10 marks)

Select 10 US listed equities with at least 5 years monthly data history. Make sure they come from at least three different GICS sectors. For example, Energy, Materials and Consumer Staples.

https://en.wikipedia.org/wiki/Global_Industry_Classification_Standard Tabulate your selection,

stating clearly which GICS sector each stock belongs. (1 mark)

Download their adjusted close prices from Yahoo! Finance in monthly frequency and calculate their monthly returns. You're free to use Bloomberg or any other data provider instead.

i) Show the correlation matrix of your selected stocks. Which pairs are most correlated; and which pairs are least correlated? (1 marks

) ii) Construct (and graph) the efficient frontier of your selected stocks. (4 marks)

iii) Construct a portfolio, using your 10 selected stocks, that minimizes total portfolio risk. Show the weights of your constructed portfolio and explain why you believe this portfolio minimises total risk. (1 marks)

iv) Construct a portfolio, using your 10 selected stocks, that minimizes the relative risk to the S&P 500 index. (3 marks) Please document your answers in the written report and provide working out in your Excel Spreadsheet.