The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generat
ID: 2616167 • Letter: T
Question
The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generate payoffs to investors next year, which depend on the state of the economy, as follows Dividend Stock Price $9 Boom Normal economy Recession $285 85 The company goes out of business if a recession hits. Assume for simplicity that the three possible states of the economy are equally likely. The stock is selling today for $75 a-1. Calculate the rate of return to Leaning Tower of Pita shareholders for each economic state. (Negative amounts should be indicated by a minus sign. Enter your answers as a percent rounded to 2 decimal places.) Rate of return Boom Normal economy Recession a-2. Calculate the expected rate of return and standard deviation of return to Leaning Tower of Pita shareholders. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Expected return Standard deviationExplanation / Answer
a-1
Rate of Return = Dividend yield + Capital gain
Boom:
Rate of Return = (D/P0) + [(P1-P0)/P0]
D=9, P0=75, P1=285
Rate of Return = (9/75) + [(285-75)/75] = 0.12 + 2.8 = 2.92 = 292%
Normal Economy:
Rate of Return = (D/P0) + [(P1-P0)/P0]
D=5, P0=75, P1=85
Rate of Return = (5/75) + [(85-75)/75] = 0.067 + 0.13 = 0.2003 = 20.03%
a-2
Expected Return = Average of all 3 economic state return = (292+20.03-100)/3 = 70.68%
Variance = 26573.85
Standard Deviation = 163.015 %
State of Economy Rate of Return Boom 292% Normal Economy 20.03% Recession -100%