What is an efficient portfolio

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Reference no: EM131283196

Question 1 - Stock Valuation Analysis (20 points)

 Valeant Pharmaceuticals (VRX) has 347m shares outstanding, $30.3 billion in debt and $597m in cash. It projects free cash flows for next 2 years based on earnings forecasts below, a marginal tax rate of 24%, capital expenditures increasing from $175m in Year 1 to $190m by Year 2, and increases in net working capital (NWC) based on a NWC-to-Sales ratio of 5% per year.

Forecasts ($m)

Year 0

Year 1

Year 2

Sales

$10,287

$13,095

$14,117

Growth vs Prior Year

 

27.3%

7.8%

Cost of Goods Sold

 

($3,274)

($3,529)

Gross Profit

 

$9,822

$10,588

Other Operating Expenses

 

($262)

($282)

SG&A

 

($2,619)

($2,823)

Depreciation

 

($171)

($171)

EBIT

 

$6,770

$7,311

(a) Determine VRX's free cash flow each year. (10 points)

(b)   Suppose VRX's free cash flow is expected to grow at 2% after Year 2. If VRX's weighted average cost of capital (WACC) is 16.7%, what is the value of VRX's stock? (10 points)

Question 2 - Portfolio Analysis (15 points)

What is an efficient portfolio? How is it related to the efficient frontier? What are the key steps involved in identifying an efficient set of portfolios for an investor? What are at least two important limitations of portfolio analysis? (10 points)

1548_Risk_and_return.jpg

Question 3 - Risk and Return (25 points) 

Consider the following information about Ford Motor Co. (F) stock on November 17, 2016:

(a) Suppose the market risk premium is 6.48% and the risk-free interest rate is 2.25% (from Ibbotson/Datastream data using S&P 500 and 10-year Treasury Note yields), calculate the expected return of investing in Ford Motor (F) stock using the CAPM? (5 points)

(b) If you believe that the analysts' consensus one-year-ahead forecast for Ford (denoted as "Target Price" in Capital IQ exhibit below) is reasonable, what risk-adjusted return would you expect to earn based on your CAPM-based calculations in (a) above? Would you buy or sell shares of Ford stock to do so? (5 points)  

(c)    Consider the data above from Berk-DeMarzo's Beta-CAPM Analyzer on Ford stock. With this data, offer at least two reasons why you might hesitate to take the action that you recommend in (b) above?  (5 points) 

2195_ford_motor.jpg

(d) In late-2016, Ford had senior-unsecured, BBB-rated, 2021 bonds outstanding with a yield to maturity of 4.07%. At the time, similar maturity Treasuries had a yield of 2.25%. Suppose the market risk premium is 6.48% and you believe Ford's bonds have a beta of 0.23. If the expected loss rate of these bonds in the event of default is 17%, what annual probability of default would be consistent with the yield to maturity of these bonds? (10 points)

Reference no: EM131283196

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