Mathematics
fixed capital
Question 1 (25%)
A division of Durham plc has been allocated a fixed capital sum by the main board of directors for its capital investment during the next year. The division’s management has identified three capital investment projects, each potentially successful, each of similar size, but has only been allocated enough funds to undertake two projects. Projects are not divisible and cannot be postponed until a later date.
The division’s management proposes to use portfolio theory to determine which two projects should be undertaken, based upon an analysis of the projects’ risk and return. The success of the projects will depend upon the growth rate of the economy. Estimates of project returns at different levels of economic growth are shown below.
Economic growth Probability of Estimated return
(annual average) occurrence Project 1 Project 2 Project 3
% % %
Zero 0.2 2 5 6
2% 0.38 9 10
4% 0.316 12 11
6% 0.225 15 11
Required:
(a) Using the above information evaluate and discuss which two projects the division is likely to undertake. All relevant calculations must be shown. (14 marks)
• Compute Standard Deviation
• Base on the 50:50 weightage
• Portfolio return and portfolio risk
• Economic growth do not take into account
• Use excel to do
(b) What is the weakness of the evaluation technique used in (a) above, and what further information might be useful in the evaluation of these projects? (4 marks)
• Limitations of the evaluation technique
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