Response to the following problem:
Tomb-zapper plc manufactures computer video games. It is considering whether to expand production at its existing site in ‘Silicon Glen' in Scotland, or to start production in a ‘greenfield site' in China, where labour costs are considerably lower than in Europe. The IRRs for each project depend on average rates of growth in the world economy over the ten-year life span of the project. These are expected to be: World growth Probability IRR China IRR Scotland Rapid 0.3 50% 10% Stable 0.4 25% 15% Slow 0.3 0% 16% Tomb-zapper wants to exploit the less than perfect correlation between the returns from the two projects, without over-committing itself to the China investment.
Required:
(a) What is the expected return and standard deviation of return for each separate project?
(b) Determine the expected return and standard deviation of an expansion programme that involves 25 per cent of available funds in China and 75 per cent in the Scottish location.