Question

ABC offers a broad portfolio of best quality vegetable oil based ingredients for application in food an non food item. The company made large profits in recent years and set aside a large reserve for future investments. The finance director of ABC bhd is in the process of preparing its capital budget for the forthcoming period and its examining a number of capital investment proposals that have been received from its directors. One of the projects coded as project R involves installation of solar panels to its existing production factory to save energy costs. The solar panels are fitted to the roof of its factory in order to reduce the company’s redendency on oil as an energy source. The solar panels would save energy cost and have an expected life of ten years. The nest cash inflow from this project is estemated at $30,000 per yearThe internal rate of return of the solar panel project is 12%. The company consultant has estimated the portfolio beta as 1.29. The project details are given below:

Investment (RM)	Project	Beta Coeffiecient
Not provided	R	Not provided
240,000	S	1.2
380,500	T	0.8
460,000	U	1.5
550,000	V	1.6

1. Calculate the figures which have not been provided.
2. Using capital asset pricing model, calculate the required return for each project (Risk Fre Rate 4%, market rate at 8%)
3. Diversification can eliminate all risks inherent in investment projects. Discuss in the context of the above.

Answer 1

		SOLAR PROJECT
	Rate	Internal Rate of Return	12%
	Nper	Number of years of cash inflow	10
	Pmt	Annual Cash inflow	30,000
	PV	Present Value of Cash Inflow	169,507	(Using PV function of excel with Rate =12%, Nper=10, Pmt=-30000)
		Investment =I
		Net Present Value (NPV)=PV-I
		At discount rate of Internal Rate of Return ,
		NPV=0
		PV-1=0, I=PV
	I	Investment =PV=	169,507
		CAPM Equation: Rs=Rf+Beta*(Rm-Rf)
		Rs=Expected Return ,
		Rf=Risk Free Rate=4%,
		Rm=Market Return=8%
		Rs=4+Beta*8
				Beta	Rs=4+Beta*8
		Investment (RM)	Project	Beta Coeffiecient	Expected Project Return
		169,507	R	1.29	14.32	%
		240,000	S	1.2	13.6	%
		380,500	T	0.8	10.4	%
		460,000	U	1.5	16	%
		550,000	V	1.6	16.8	%
		Diversification elliminates the unsystematic risks
		However, systematic risk or the market risk cannot be elliminated