Marine Fisheries is an established company which is looking to expand its fishing interests by purchasing a 100% interest in Shark Bait. The management of Marine Fisheries believes that the expected returns from the acquisition of Shark Bait are dependent on the state of the economy.

The following information is made available: Estimated return

State of the economy

Probability of occurrence 0,3

0,4 0,3

1. Determine whether Marine Fisheries should acquire Shark Bait in line with the portfolio theory. (14 Marks)

2. Illustrate and explain what the term risk premium means in the context of the portfolio theory and calculate the required return for a portfolio that has the same return/risk characteristics as Marine Fisheries. (8 Marks)

QUESTION 2 28 MARKS

Bean Ltd is a division of Earl Enterprises and has been allocated R5 million for capital expansion in the forth-coming year. The management of Bean Ltd believes that the company must spread its risk by investing in projects with different risk profiles and has identified two possible investments.

Marine Shark The Fisheries Bait market

Favourable

Neutral

Unfavourable

Book value in million

Market value in million

Standard deviation of returns

Covariance with the market

The risk-free rate is 5% and there is no company or personal taxation.

16% 20% 14% 10% 12% 8% 2% 0% 6% 12m R8m R8m R12m 5,4% 7,8% 3,2% 0,0024 0,0023