Question
a) The Investment Director of Mutsva Company is considering the following two stocks:OM and NT. The Director provides you with the following data for the
a) The Investment Director of Mutsva Company is considering the following two stocks:OM and NT. The Director provides you with the following data for the two stocks.
Stock OM STOCK NT
Expected return (%) 8 20
Standard Deviation (%). 18. 24
(i) Calculate the expected return and variance for the following portfolios assuming the correlation coefficient between the two securities is +0.5.
Portfolio A - 100% OM
Portfolio B- 75% OM and 25% NT
Portfolio C- 50% OM and 50% NT
Portfolio D- 25% OM and 75% NT
Portfolio E- 100% NT[10 marks]
(ii) Do you think the two stocks have a diversification effect? Motivate your view. [4 marks]
b) Examine the limitations of Markowitz portfolio risk estimation.[10 marks]
b)Ngorima Electronics is evaluating an expansion project that is expected to cost $20 million and generate an annual after-tax cash flow of $4 million for the next 10 years.The tax rate for the company is 35%.
Ngorima Electronics has target debt-equity ratio of 1:1.Its cost of equity is 16,9% whereas its pre-tax cost of debt is 14%.The floatation cost of equity is 12% whereas the floatation cost of debt is 14%.
What is the NPV of the expansion project and is the expansion project worth implementation?[16 marks]
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