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]