The common stock of Leaning Tower of Pita, Inc., a restaurant chain will generate the following payoffs to investors next year:

Dividend Stock Price

Boom $5.00 $195

Normal economy $2.00 $100

Recession $0.00 $0

The company goes out of business if a recession hits. Calculate the expected rate of return and standard deviation 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 $90.

Solution

Problem 9-14

Instructions

Enter formulas to calculate the expected rate of return on the stock. Use the MS Excel STDEVP function to calculate the standard deviation.

Stock price today $90.00

Expected return

each scenario

Boom FORMULA

Normal economy FORMULA

Recession FORMULA

Expected rate of return FORMULA

Standard Deviation FORMULA

Dividend Stock Price

Boom $5.00 $195

Normal economy $2.00 $100

Recession $0.00 $0

The company goes out of business if a recession hits. Calculate the expected rate of return and standard deviation 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 $90.

Solution

Problem 9-14

Instructions

Enter formulas to calculate the expected rate of return on the stock. Use the MS Excel STDEVP function to calculate the standard deviation.

Stock price today $90.00

Expected return

each scenario

Boom FORMULA

Normal economy FORMULA

Recession FORMULA

Expected rate of return FORMULA

Standard Deviation FORMULA

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