Question

1. Based on DHC's earnings history over the past 15 years, which have covered various states of the economy, the venture capital execs want DHC to estimate their overall returns. Given the following estimates of economy over the next several years, determine DHC's expected rate of return. (3 pts)  

Note, this type of development firm has much higher than normal returns under normal and boom conditions.                                                                    

State of the Economy	Probability of State of the Economy	Rate of Return if State Occurs
Boom	20%	35%
Normal	55%	12%
Recession	25%	-15%

Expected return for “average” company project =

Answer 1

expected rate of return = Sum of ( probability of state * rate of return of state)

= 0.2 * 0.35 + 0.55 * 0.12 + 0.25 * -0.15

= 0.0985

= 9.85%