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Homework answers / question archive / Question 1 For this question, assume taxes, depreciation and amortization are always equal to zero

**Question 1**

For this question, assume taxes, depreciation and amortization are always equal to zero. Consider an all?equity firm with market capitalization equal to $10,000, earnings equal $600 per year, and with zero cash.

- What are the P/E and EV/EBITDA of the firm?

The firm then decides to change its capital structure. It takes on $6,000 of debt and use all debt proceeds to buy back its own stock. The new debt is a perpetuity with interest rate equal to 3% per year. - What are the P/E and EV/EBITDA of the firm after the capital structure change?
- Based on your answers to a) and b), explain why, compared to P/E ratios, EV/EBITDA is a conceptually superior

valuation ratio.

**Question 2**

When defining the Russell 3000 Value and the Russell 3000 Growth (or Glamour) indices, Russell separate stocks according to Price to Book Ratios only. In contrast, when defining the S&P 1500 Value and S&P 1500 Growth (or Glamour) indices, S&P uses a combination of P/B, P/E and P/Sales. Discuss which approach is superior in terms of capturing the outperformance of Value over Growth (or Glamour).

**Question 3**

Choose one signal from each of the following classes of signals: Value, Quality, Risk, Price Trends, and Information. For each signal, explain:

- How is the signal calculated?
__Explain__precisely what you calculate in each case - Which direction does it go? (I.e., high signal means low or high stock returns going forward?)
- Provide one
*potential*explanation for why the signal is able to forecast relative stock returns.

**Question 4**

In a meeting of an investment fund, Andrew is pitching stock ABC, while Ximena is pitching stock XYZ.

To support his pitch, Andrew mentions that most sell?side analysts covering ABC have "strong buy" recommendations, while most sell?side analysts covering XYZ have "hold" recommendations. Both stocks are part of the S&P1500 index. Does Andrew have a good point? Make sure to support your answer using output from Portfolio123.

*Hint: How would you use Portfolio123 to verify whether analyst recommendations can forecast relative stock returns?*

**Question 5**

Backtest the performance of the UM Super Combo ranking system over MAX time period using three Universes: S&P 500, Russell 3000, and ALL FUNDAMENTALS. Use the following parameters: All Sectors, Minimum Price=3$, rebalancing every 4 weeks, 10 buckets.

- Copy paste the bar graphs with annualized returns.
- Explain as well as you can the calculations P123 does to generate the graphs above.
- In which of the Universes does the UM Super Combo ranking system "work" best? TO measure how well it works, consider the spread between the extreme buckets, and the smoothness (monotonicity) across buckets.
- Can you rationalize the results in c?

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