Question

Precision Group has estimated the potential returns that may be achieved from a project, together with the likelihood of such returns occurring, detailed in the table below: Possible Returns to Probability of occurence is a) -8% , 10% b) 5% , 20% c) 12% , 50% and d) 27% , 20%. Precision Group has also estimated that the risk of this project, measured with Beta, is 1.2. The market portfolio that they have chosen has returned an average of 11% per annum over the past 8 years. The current risk free rate is 4%. i. Calculate the expected return and the standard deviation of returns for this investment. ii. Identify whether Precision Group should invest in this project. Provide a reason for your decision.

Answer 1

	Return	Probablity
a	-8.00%	10%
b	5%	20%
c	0.12	50%
d	27%	20%
1	Expected return	11.60%	Using the formula sumproduct of probablity*reurn
	Std deviation	12.87%	squareroot(probablit*(return-expected return)^2)
2	Beta	1.2
	Risk free rate	4%
	market return	11%
	Required rate of return	12.40%	Using CAPM - Risk free rate + Beta*(Market return-Risk free rate)
	Since the expected return is less than required rate of return Precision group should not invest