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FNCE 6330
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Fall 2023
FNCE 6330 – Exam 1 Fall 2023
Dr. Kwabena Kesse
This exam is to be done independently although you may consult with me or with your notes or textbook
or any reference material you desire. You are not to consult with any other individual; if you do and I
suspect any plagiarism, you will be given a zero on this exam.
This exam consists of 3 problems and is worth 100 points.
This exam is due on December 3, 2023, at 11:59 PM MT as per the syllabus. Please upload the exam to the
required folder on Canvas.
Late exams will be given zero credit. Since this is a take home exam and you have two weeks to complete
it, I will make no exceptions and will not grant any extensions.
I recommend using Microsoft Excel to organize your work as some of the computations (not all) will be tedious
if done with a hand-held calculator.
Make sure that your answers are directly related to the questions being asked. I will not be grading answers, I
will grade your thought-process. Also, read questions carefully and pay attention to the point in time, especially
on questions involving time value of money that require you to find present values. We have discussed many
theories and principles in this course, and my goal is to encourage you to take that knowledge and apply it to
solve problems in finance.
Please read the following statement and sign
I understand that this is a take-home exam and that while I can consult with the course instructor and
reference any material I desire, I agree to work solely on my own and will not consult with anybody be it
in this class or anywhere. If I fail to adhere to the aforementioned agreement, then I do understand that I
will be subject to academic misconduct.
Signature: ……………………………………………………………………………
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Problem 1 (35 points)
It is the end of 2023 and the latest reported information from Lockheed Corporation’s 10-K reports an EBITDA
(earnings before interest, taxes, depreciation, and amortization) of $4,000 million in 2023, prior to interest
expenses of $1,000 million and depreciation charges of $600 million. Capital expenditures in 2023 amounted to
$1,000 million, and working capital required was approximately 8% of revenues (which was $20,000 million).
The change in our working capital from year to year will represent our investment in working capital. The tax
rate for the firm is 21%.
The firm has debt outstanding trading at a market value of $20.0 billion and yield a pre-tax interest rate of 8%.
There are 100 million shares outstanding, trading at $250 per share, and the most recent beta was 1.20. The
Treasury bond rate is 3%, and the market risk premium is 6.5%.
The pre-tax interest rate, tax rate, beta, treasury bond rate, market risk premium, market value of debt and
market value of equity are used to estimate a weighted average cost of capital (WACC) of approximately
8.8%. (I have estimated the WACC or discount rate for you using the cost of debt, cost of equity and the
information in the preceding two paragraphs.)
The firm expects revenues, earnings (EBITDA) and depreciation to grow at 10% a year from 2023 to 2026, after
which the growth rate is expected to drop to 3% a year forever.
Capital expenditures will also grow at 10% a year from 2023 to 2026, but capital spending will be 120% of
depreciation in the steady/terminal state period. The working capital required will continue to be 8% of
revenues as shown in the table below (table has been provided as a guide to help you organize your work and
get to the Free Cash Flow to the Firm):
a) Estimate the free cash flow to the firm for each of the following indicated years.
Year 2023
0
Year 2024
1
Year 2025
2
Year 2026
3
Year 2027
4
Revenues (millions)
20,000
22,000
24,200
26,620
27,419
Working Capital Required (millions)
1,600
1,760
1,936
2,130
2,193
160
176
194
Growth Rate
EBITDA
Depreciation
EBIT
Taxes
EBIT(1-T)
Capital Expenditures
Change in Working Capital (millions)
64
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Free Cash Flow to Firm
b) Estimate the Enterprise Value of Lockheed (value of the firm’s operations).
c) Lockheed has $800 million in cash. Estimate the Market Value of Equity and estimate the intrinsic share
price of Lockheed.
d) If you had to make a recommendation on this stock based on your estimation of its intrinsic value, what
would it be? Briefly explain your recommendation for the stock of the company. (As a reminder, stock is
currently trading at $250 per share).
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e) Assume that today is December 31, 2023, and that the following information applies to Abner
Airlines, a relatively mature company:
• After-tax operating income [EBIT(1-T)] for the end of year 2023 was $600 million.
• The depreciation expense for 2023 was $140 million.
• The capital expenditure for 2023 was $225 million.
• No change in net operating working capital
• The free cash flow is expected to grow at a constant rate of 3.5% per year perpetually
• The cost of equity is 14%
• The weighted average cost of capital (WACC) is 10%
• The market value of the company’s debt is $3.875 billion
• 200 million shares of stock are outstanding.
What should be the intrinsic value of the stock’s price?
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Problem 2 (35 Points)
a. You have been given the monthly prices for MacDonalds stock and the SPY (an ETF that tracks the
S&P 500 index) in the attached excel file for the last 5 years.
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
Compute the monthly returns for both MacDonalds and SPY
Compute the arithmetic and geometric average returns for MacDonalds and SPY. Which of
these two average returns is more appropriate for describing the performance of MacDonalds
and SPY over the investment period?
Compute the standard deviation of the returns for MacDonalds and for the SPY ETF
Compute the covariance between the returns on MacDonalds stock and the SPY ETF
Compute the correlation co-efficient between the two assets
Assume the SPY ETF is the proxy for the market portfolio and compute the beta for
MacDonalds.
What does the beta you have computed signify and how do you interpret it?
Would you conclude that MacDonalds is a defensive or cyclical stock based on the beta
estimate?
b. Consider the following assets with the following potential returns under the economic scenarios given:
Scenario
Probability
Asset A
Asset B
Severe Recession
0.05
-35%
-8%
Mild Recession
0.25
-10%
10%
Normal Growth
0.40
14%
8%
Economic Boom
0.30
30%
-10%
i.
Compute the expected return, standard deviation, covariance, and correlation coefficient of Assets A &
B.
ii. Form a portfolio by putting half the allocation (50% weight in each of A and B) to form a portfolio of 2
risky assets and compute the expected return and standard deviation of the portfolio of the two
risky assets. What conclusions can we draw about diversification from your calculations?
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Problem 3 (30 Points)
a) An analyst gathered the following data about stocks J, K, L and M. Suppose we want to create an index
from these four stocks.
Stock
J
K
L
M
December 31, Year 1
December 31, Year 2
January 1, Year3
Share
Price
$42
$28
$50
$60
Share
Price
$50
$28
$60
$65
Share
Price
$50
$14
$60
$67
No. of Shares
Outstanding
10,000
6,000
9,000
5,000
No. of Shares
Outstanding
10,000
6,000
9,000
5,000
No. of Shares
Outstanding
10,000
12,000
9,000
5,000
i.
Calculate the rate of return on a price-weighted index of the four stocks from Year 1 to Year 2.
ii.
What will be the divisor for the price-weighted index on January 1, Year 3 (Note that K undergoes a
stock split at close of day December 31, Year 2)?
iii.
Calculate the rate of return on an equal-weighted (unweighted) index of the four stocks from Year 1
to Year 2.
iv.
Calculate the rate of return on a value-weighted index of the four stocks from Year 1 to Year 2.
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b). You open a brokerage account, and purchase on margin 800 shares of Xcel stock at $55 per share. Initial
margin on the account is 50%, and the maintenance margin is 30%. The interest rate on borrowed fund is 7%
per year.
i.
How low can the price of Xcel shares fall before you receive a margin call? Ignore interest on this
problem.
ii.
If the share price falls to $39 per share by the end of the year, what is the remaining percentage
margin in her account? Will you receive a margin call?
iii.
You sold the 800 shares of Xcel at $60 per share at the end of the year. Also, assume your broker
charged a commission of $50 to execute the buy order and charged a commission of $50 to execute
the sell order. What is the rate of return on your investment?
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c.) Suppose you short-sell 100 shares of IBM, now selling at $160 per share. Initial margin on the account is at
50% and maintenance margin is at 30%.
i.
At what price would you get a margin call?
ii.
Three months later, IBM pays a dividend of $1/share, and its share is now traded at $130 per share.
Ignore commission.
•
What is the remaining equity in your account at this point?
•
What is the margin percentage in your account at this point?
•
What is the rate of return on your transaction?
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