The common stock of Leaning Tower of Pita Inc., a restaurant chain, will generat

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 Normal economy Recession $10 6 90 ? 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.) 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

Solution:-

a-1) Rate of return

                          Boom = 237.5%

     Normal economy = 20%

                    Recession= -100%

Calculations:-

Rate of return = Dividend +Stock price next year-stock price today)/stock price today

i) Boom rate of return = (10+260-80)/80=237.5%

ii)Normal economy = (6+90-80)/80=20%

iii) Recession = (0+0-80)/80 = -100%

a-2) Expected return = 52.5%

        Standard deviation= 139.69%

Calculations:-

i) Expected return = Sum of expected return in different scenario/ n

                                  =(237.5%+20%-100%)/3 =52.50%

ii) Standard deviation = Square root of (sum of square of expected return in each scenario -average return)/n

=[{(237.5-52.50)2+(20-52.50)2+(-100-52.50)2}/3](1/2)

=[(34,225+1056.25+23,256.25)/3](1/2)

=139.69%

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