% WATERLOO Please print in pen: | ct! Examination Midterm (Version B) Fall 2022 ‘Times: Tuesday 2022-11-08 at 10:00 to 11:15 ACTSC 372 Duration: | hour 15 minutes (75 minutes) Exam ID: 5085933 Sections: ACTSC 372 LEC 001,002 Special Materials Instructors: Peter Wood, Surya Banerjee Candidates may bring only the listed aids. - Calculator - Scientific SolN SPECIAL NOTE: Please note that no questions will be answered by either the TAs or by the instructor. If you are uncertain as to how to proceed in a question, please make the most common sense assumptions. If necessary, state the additional assumptions you feel are needed in order to answer the question. If you require extra space for a solution, please use the blank page provided at the end of the exam, Please clearly indicate in the solution space that your answer continues on the blank page. ‘THIS EXAM IS PRINTED ON BOTH SIDES. ‘The exam will be marked out of 35 points. ACTSC 372 Fall 2022 Midt: Fes ina © 2022 University of Waterloo. Page 1 of 10[2] 1. A project costing $20 million in expected to generate net cash flows of $4 million per year in perpetuity. Compute the payback period and the IRR. Pray beck. = Wr 2 Sor olye TR seb Os -Qom - Um 2 DRA> Do, TER 2) 2. ‘You are considering investing in one of 2 projects, A and B. Both projects cost $100,000. Assume for this question that the nominal discount rate is 8% and inflation is 4%, Project A generates $13,000 per year (nominal) in perpetuity while Project B generates $6,000 per year (in real terms) in perpetuity. Which do you prefer? Why? Mu, = —]@k + a > 625K 8]. Nil > jak + GK hee (ray )Cir11) = Cr) 2 Stk ‘ =) f= 3,94) Choose A since its Meu is higher [2] 3. Youneed a delivery truck for your business. Your choices are to lease a truck for $10,000 per year, or buy one. If you buy one, it will cost $75,000. After 10 years, you can sell it for a salvage value of $10,000. Your company uses a discount rate of 10%. If you lease, you can lease for as long as you want. Should you buy a truck, or lease one? Explain. =. osk — be FAC Guy 6 dr" = Ist 9 Fol py Eb pease = JO = lease. 15 cheaper Pisa ia ‘ACTSC 372 Fall 2022 Midterm © 2022 University of Waterloo P age 2 of 10BI 2] GB) Accompany is considering 2 independent projects A and B. If Pl, = 0.9 and Ply then ‘We accept Project A We accept Project B We accept both projects d. We accept neither project. The PVCCATS value is more valuable if we apply the half-year rule GB) is less valuable if we apply the half-year rule . the effect of the half-year rule on value depends on the CCA rate 4. the effect of the half-year rule on value depends on the discount rate An investment manager is assessing the performance of 2 oil companies. The correct measure of relative performance (according to CAPM) is a. The firms’ relative betas b, The firms’ Sharpe Ratios The firms’ Traynor Ratios @. The firms’ relative volatilities Define what we mean by a “sunk cost”. How do we account for sunk costs in capital budgeting? A sunk cosk 13 @ cost alrecly spent bedre moking Fhe Prrel cleersion. DH} ts ignoreol Fer capited bed geting ‘Your friend is convinced they have a secret trading strategy that will make lots of money. ‘They suggest you buy Bitcoin the day after the S&P500 falls by more than 1% on a given day. If this strategy works, what form(s) (if any) of the EMH does this violate? All Roms. E+ # bosect om pash prices only ACTSC 372 Fall 2022 Midterm pasa © 2022 University of Waterloo Page 3 of 10[8] 7. Pizzaflut is planning to open a new pizza location in DC. They make the following projections regarding the new location: ‘© It will cost $1 million to open the location. Sales are expected to be 500 pizzas per day. We assume the university is open for students 250 days per year. » Each pizza sells for $12, and the variable costs are $8 per pizza © PizzaHut must pay the Dean of Math $20,000 per month for rent. Assume there are no other fixed costs and the company pays taxes at a rate of 25%. Assume the company uses a discount rate of 10% for this project. + Assume the project will last 20 years, at which time the location will be closed and no more cash flows will occur. ‘* Assume for simplicity that all operating cash flows occur at the end of each year. (@) (Spt) Should PizzaHiut open the location? Explain. parr |e + [s+ as «(19 -¥) = Dok e\CI-952) = Gbok 7° Hes, they shoul gm ACTSC 372 Fall 2022 Midterm sine © 2022 Thane of Waterloo Page 4 of 10(©) (2pt) Assume the actual sales is a random variable, N, with o(N) = 100. Compute (NPY). Mee Jm & Ne 980 #9 BCI) 2 Tp nk 6395: Nv ry or (yn) 2 Gaes ROE 2% ges nN. (©) (Ip®) Ifye were to compute the IRR of this project then: the IRR will be unique Ti) there may be as many as 2 different IRRs iii) there may be even more than 2 different IRRs. We can’t know for sure until wwe do the calculations ACTSC 372 Fall 2022 Midterm esse il © 2022 University of Waterloo Page 5 of 10CROWDMARK [8] 8. The expected returns and standard deviations of three tisky assets are given below Seanngy “Expected Return Standard Deviation Correlations sti : Ae BoC. A 11% 30% 1.0 0.3 0.15 B 14.5% 45% 03 10 045 3 9% 30% 0.15 045 1.0 (a) (3pt) Suppose you have a portfolio P with equal weights on Stocks A, B, and C. Calculate. the expected return and standard deviation of portfolio P. by > 1,0) Eyes + KC gp) = MSI 5,5 = (sTGor) QTE HU) GIT + 2G) Crit if ra (yO) (B01) L807) » 2676.57) (1) 2 0. obY =I fn> 2bE (>) Qpt) Calculate the Sharpe Ratio of P (assume ry = 4%). ~ Oo-& . wSICYL 2 oQert Sk> a > — wl e ACTSC 372 Fall 2022 Midterm © 2022 University of Waterloo Page 6 of 10 |(©) Gpt) Assume you have a portfolio of only assets B and C. Determine the weight in Asset B such that the total portfolio risk is minimized. p= Ler (-t ye ioe ths y k UY Bo bd (OU-4) (30) L457) 6 6 2 AL YSLY 4 Beit — 24 G0 HE C481)" Fae Bor lrsjer - 24° GoNLA 124) i sae (47)? = a(n) + 2480)" # AGALHN GID ~ HEBIYsIod =O aoe te tld ACTSC 372 Fall 2022 Midte ese ii © 2022 University of Waterloo. Page 7 of 10fo OMB Uae (5] 9. Youhave analyzed the retums on various securities, and you believe that they are best modeled with a one factor APT model. More specifically, assume Ry = Ry + By(F FD + & where X is a typical security in the market. Assume the firm specific risks and the factors are all independent from each other. Suppose Var(F) = 0.007. Suppose there are 2 securities in the market A and B, with the following data: Security B Var(e) | Expected Return A 5 0.02 4% B 1.25 0.04 9% (2) @pt) Construct a portfolio not sensitive to the systematic risk factor. S 4G a=! E Pood +b | a8 Pe> al t\tbhllas\ 0 be-bk (b) (2pt) Compute the variance of this portfolio. Gy'> Br Werle) + a tar Ge) +b verles = 0 + 0.2915 > OUT ACTSC 372 Fall 2022 Midterm fake © 2022 University of Waterloo Page 8 of 10