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Leaning Tower of Pita Expected Rate of Return

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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

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Solution Summary

Excel spreadsheet calculates expected rate of return, standard deviation, etc. for a couple questions given.

Solution Preview

Stock price today $90.00

Expected return
each scenario
Boom = (Dividend + Price at year end - price now)/Price now = (5+195-90)/90 = 1.2222 or ...

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