ABCO is a conglomerate that has ksh4 billion in common stock. Its capital is invested in four
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ABCO is a conglomerate that has ksh4 billion in common stock. Its capital is invested in four subsidiaries: Entertainment (ENT), Consumer products (CON), Pharmaceuticals (PHA) and insurance (INS). The four subsidiaries are expected to perform differently, depending on the economic environment as follows:
Investment in ksh millions | Poor economy | Average economy | Good economy | |
ENT | 1,200 | 20% | -5% | -8% |
CON | 800 | 15% | 10% | -20% |
PHA | 1,400 | -10% | -5% | 27% |
INS | 600 | -10% | 10% | 10% |
Assuming that the three economic outcomes (1) have an equal likelihood of occurring and (2) that the good economy is twice as likely to take place as the other two:
- Calculate the individual expected returns for each subsidiary
- Calculate the implicit portfolio weights for each subsidiary and an expected return and variance for the equity in the ABCO Conglomerate
- Asssume in a) above that ABCO also has a pension fund, which has a net asset value of ksh 5 billlion, implying that ABCO’s stock is really worth ksh 9 billion instead of ksh 4 billlion. The sh 5 billion in pension fund is invested in short term government risk free securities yielding 5% per year. Recalculate parts i) and ii) of a) to reflect this information.
- Assume the in a), ABCO decides to borrow sh 8 billion at 5% interest to triple its current investment in each of its four lines of business. Assume that this new investment has the same return outcomes as the old investment.
- Answer part i) and ii) of a) given the new investment
- How does this result compare with the results from a)?
- To whom does this return belong? Why?
- Explain how ABCO would manage its portfolio prudently
Related Book For
Financial Reporting Financial Statement Analysis and Valuation a strategic perspective
ISBN: 978-1337614689
9th edition
Authors: James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
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