The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generat
ID: 2797429 • 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 Boom $ 8 $ 240 Normal economy 4 90 Recession 0 0 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 $80. 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.) 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.)
Explanation / Answer
Probability of each state = 0.3333
Boom:
Dividend = 8 * 0.333333 = 2.67
Stock Price = 240 * 0.33333 = 80
Current Price = 80
Current price using probability = 80 * 0.33333 = 26.67
Required rate fo return = (80 + 2.67 - 26.67)/ 26.67
Required rate of return = 209.97%
Normal:
Dividend = 4 * 0.333333 = 1.33
Stock Price = 90 * 0.33333 = 30
Current Price = 80
Current price using probability = 80 * 0.33333 = 26.67
Required rate fo return = (30 + 1.33 - 26.67)/ 26.67
Required rate of return = 17.47%
Recession:
Dividend = 0 * 0.333333 = 0
Stock Price = 0 * 0.33333 = 0
Current Price = 80
Current price using probability = 80 * 0.33333 = 26.67
Required rate fo return = (0 - 26.67)/ 26.67
Required rate of return = -100%
Expected Price = 80 + 30 = 110
Dividend = 2.67 + 1.33 = 4
Requred rate = (110 + 4 - 80)/ 80
Requred rate = 42.50%