INSTRUCTIONS:This question contains two (2) parts. Respond to both parts. In your answer, use bold text to label your response to each part (e.g.Part a):Your response...)

Part a):Given the cash flows below, calculate the NPV, the NPVI Ratio, the Payback and the Equivalent Annual Value of the project using a10%pa cost of capital. Ignore inflation and taxes. Show all your working and explain your processes.

01234-200009000800091009000

(5 marks)

Part b):You currently have all your funds invested in a portfolio of shares of Polycorp (PLC). The shares have an expected return of 10%pa and a standard deviation of 20%pa. You are offered the opportunity to invest in two funds managed by the Rearguard Portfolio Management Company. One is a Bond Fund that has an expected return of 5%pa and a standard deviation of 5%pa. The other fund is one that tracks the market index and has an expected return of 15%pa and a standard deviation of 25%pa. The correlation between the index fund and the bond fund is 0.1. Construct a portfolio of the Index and Bond funds that gives the same expected return as a portfolio of Polycorp shares. What is the composition and standard deviation of this portfolio? Use this example to comment on the benefits of diversification.