The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generat
ID: 2804779 • 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 $ 220 Normal economy 4 110 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 $100. 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 deviation %
Explanation / Answer
a-1.
Dividend Stock Price
Boom $ 8 $ 220
Normal economy 4 110
Recession 0 0
Current price= 100
return in boom = [(220+8)/100]-1 = 2.28 - 1 = 1.28 = 128%
return in normal economy = [(110+4)/100]-1 = 1.14-1 = 0.14 = 14%
return in recession = -100%
a-2.
as all outcomes are equally likely:
expected return = (128+14-100)/3 = 14%
sd =[ [(128-14)2 + (14-14)2 +(-100-14)2 ]/(3-1) ]1/2= [(12996+0+12996)/2]1/2 = 129961/2 = 14%