ABC Inc., an all-equity financed company, is a manufacturer whose core operation is the production of robotic

Fantastic news! We've Found the answer you've been seeking!

Question:

ABC Inc., an all-equity financed company, is a manufacturer whose core operation is the production of robotic machines and transports. The CFO of the company is considering two independent projects. The first project, A is the production of robotic trains used in upscale shopping and leisure complex for carrying patrons within the facility. The second project, B is the production of robotic maids used to gradually replace human domestic helpers. The CFO of ABC hires you to perform relevant financial analyses and determine the feasibility of these projects. You estimate that the expected return and standard deviation for A are 16% and 12%, respectively, and those for B are 18% and 15%, respectively, for the upcoming year. The correlation between the two projects is estimated to be 0.35. Assume the Capital Asset Pricing Model (CAPM) is valid and the beta of a project is expected to remain unchanged in the foreseeable future.

a) What are the expected return and standard deviation of an equally-weighted portfolio consisting of A and B? Do you see any benefit from diversification? Explain in one or two sentences.

b) Your estimates of the betas for A and B are 1.52 and 1.65, respectively. What are the required returns for A and B for the upcoming year according to the CAPM? Assume the market risk premium to be 7% and the risk-free rate of return to be 4%.