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		$	9			$	225
Normal economy			5				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	%

Answer 1

(A) Boom

Rate of Return = Dividend + [(Stock price - Sellingprice) / Selling price]

   = 9 + [(225 - 100) /100]

= 10.25 %  

Normal Economy

Rate of Return = Dividend + [(Stock price - Sellingprice) / Selling price]

   = 5 + [(110 - 100) / 100]

  = 5.10 %

Recession

Rate of Return = Dividend + [(Stock price - Sellingprice) / Selling price]

   = 0 + [(0 - 100) / 100]

   = -1 %

(B) Expected Return

	Probabilty	Return (%)	Expected Return (%)
Boom	.33	10.25	=(10.25* .33) = 3.3825
Normal Economy	.33	5.10	=(5.1 * .33) = 1.683
Recession	.33	-1	=(-1 * .33) = -.33
TOTAL			=4.7355%

Expected Return = 4.7355%

Standard Deviation= 1.25