Reference no: EM132428762

Problem: Transbot 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 contemplating investing in two independent projects. The first project, RoboTrain is the production of robotic trains used in upscale shopping and leisure complex for carrying patrons within the facility. The second project, RoboMaid is the production of robotic maids used to gradually replace human domestic helpers. The CFO of Transbot hires you to perform relevant financial analyses and determine the feasibility of these projects.

Based on estimates provided by your assistant, the expected return and standard deviation for RoboTrain are computed to be 16% and 12%, respectively and for RoboMaid 18% and 15%, respectively for the upcoming year. The correlation between the two projects is estimated to be 0.35.

The stock returns for Transbot and the market (S&P 500 index) for the past 5 years are presented to you by your assistant as follows:

Year Transbot's stock returns       Market returns

2014 28%                             12%

2015 12%                             11%

2016 27%                             17%

2017 11%                             12%

2018 15%                             9%

Assume the Capital Asset Pricing Model (CAPM) is valid and the firm beta is expected to remain unchanged in the foreseeable future. 7

Required

Question 1: Calculate the mean return and standard deviation for Transbot's stock returns.

Question 2: Determine the stock beta for Transbot.

Question 3: What are the expected return and standard deviation of an equally-weighted portfolio consisting of RoboTrain and RoboMaid? Do you see any benefit from diversification? Explain in one or two sentences.

Question 4: Your beta estimate for RoboTrain and RoboMaid are 1.52 and 1.65, respectively. What are the required returns for RoboTrain and RoboMaid for the upcoming year according to CAPM? Assume the market risk premium to be 7% and the risk-free rate to be 4%.

Question 5: Would you advise your CFO to proceed with these investments? Is it appropriate to use the firm's hurdle rate as benchmark comparison when making your decision? Explain your answer.