Problem
a) Mary wishes to establish an investment portfolio comprising of shares listed on the Australian Securities Exchange. Her financial planner advises that the portfolio should be built with perfectly positively-correlated shares.
Explain what is meant by the term ‘investment portfolio'. Advise Mary on whether the financial planner's advice is sound. Provide reasons for your advice.
b) Shoal Haven Ltd plans to raise $100 million for a capital expansion project. The fundraising structure includes 70% from the issue of ordinary shares to existing shareholders and 30% from issuing unsecured notes (debt). Shareholders expect a 12% return on funds invested. The pre-tax cost of debt is 10%. The corporate tax rate is 30%.
Calculate and explain the discount rate (Weighted average cost of capital WACC) that Shoalhaven Ltd should use. What limitations exist in using the firm's discount rate as an investment hurdle rate?