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 $8 $240

Normal Economy $4 $90

Recession $0 $0

The company goes out of business if a recession hits. Calculate the expected rate of return and standard deviation of return to Leaning Tower of Pita shareholders. Assume for simplicity that the three possible states of the economy are equally likely. The stock is selling today for $80.

Explanation / Answer

today market price 80 dividend dividend yield = dividend / market price market price capital gain yield = capital gain / market price total returm = dividend yield + capital gain yield boom 8 0.1 240 0.666666667 0.766666667 normal 4 0.05 90 0.125 0.175 recession 0 0 0 -1 -1 Average return -0.01944444 total return total return - average return (total return - average return)^2 boom 0.766666667 0.786111111 0.617970679 normal 0.175 0.194444444 0.037808642 recession -1 -0.980555556 0.961489198 sum of (total return - average return)^2 1.617268519 average return -0.019444444 Variance 0.539089506 sum of (total return - average return)^2 / n 0.734227149 standard deviation 0.734227149 square root of variance

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