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Question 1: Measures of Return and Risk (20 marks)

Assume the following information of two investments A and B are possible in 2023:

Economic Status

Weak Economy Static Economy Strong Economy

Probability

Rate of Return

Investment A

Investment B

-6% 6% 14%

invest in? Explain. (Show ALL workings)

Question 2: Security Market Line (20 marks)

(10 marks)

0.30 -4% 0.30 6% 0.40 12%

  1. a)  Compute the standard deviation and coefficient of variation of the rate of return for each investment? (10 marks)
  2. b)  Based on the results calculated above, if you are not a risk-taker, which investment should you

Assume you are an investor based in New Zealand. Draw a labelled graph of the Security Market Line (SML) and show graphically the effects of the following changes on the SML. Explain your answers (maximum of 100 words per question).

  1. a)  The expected long-run growth rate of the New Zealand economy decreases by 1%;
  2. b)  The expected rate of inflation does not change;

(5 marks) (5 marks)

c) The yield spread between Bbb corporate bonds and Aaa corporate bonds has increased from 300

basis points to 350 basis points; and
d) The Economic Policy Uncertainty Index of New Zealand has droped from 108 to 100.

(5 marks) (5 marks)

2

Question 3: Free Cash Flow to the Firm (FCFF) (40 marks)

Assume you consider acquiring a company MRK with the following information:

Sales in 2022
Sales growth for five years (2023 – 2027) Sales growth after 2027
Operating margin
Tax rate
Net margin
Debt
Pre-tax cost of debt
Number of shares outstanding
Book value of equity
Book value of assets
Percentage of NOPAT reinvestment:

Reinvestment rate for five years (2023- 2027)

Reinvestment rate after 2027

Market value of equity Market value of debt Cost of equity

50.00 billion $ 3.00 %
2.50 %

35.00 %
28.00 %
20.00 %
35.00 billion $

4.50 %
10.00 billion 55.00 billion $ 90.00 billion $

35.00 %

40.00 % 160.00 billion $

35.00 billion $ 8.00 %

  1. a)  Using the Free Cash Flow to the Firm (FCFF) model, estimate the Enterprise Value (EV) of MRK and the intrinsic value of the MRK stock. (20 marks)
  2. b)  If the Free Cash Flow to Equity (FCFE) model is used, without any calculations, will the intrinsic value of the MRK stock increase or decrease? What are the reasons of this change? Explain. (maximum of 200 words)
    Note: Please refer to the Case study 1 on the course LEARN page for your research and explanation. (20 marks) (Show ALL workings)

Question 4: The Top-Down Approach (20 marks)
Please answer the following regarding the Market Analysis (maximum of 150 words per question):

  1. a)  Explain why or why not you recommend Gross Domestic Product (GDP) growth rate to your clients (who want to invest in stocks) for the Aggregate Market Analysis in the Top-Down Approach. (10 marks)
  2. b)  Assume your clients want to invest in stocks in the Asia Pacific markets in 2023 and use a leading indicator such as Manufacturing PMI (Performance of Manufacturing Index) (data available at https://tradingeconomics.com/countries) for decision making. Based on the Manufacturing PMI data solely, which stock markets in the Asia Pacific region would you like to advise your clients to invest in? Explain your decisions. (10 marks)

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[TOTAL 100 MARKS]

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