Eagle Adventures, Inc. stock is quite cyclical. In a boom economy, the stock is expected to return 30%, 12% in a normal economy, and negative (20%) in a recessionary period. The probability of a recession is 15%. There is a 30% chance of a boom economy. The remainder of the time, the economy will be at normal levels. What is the overall expected value of the returns on Eagle Adventures, Inc. stock

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Business

Eve Harris

30 January, 07:13

Eagle Adventures, Inc. stock is quite cyclical. In a boom economy, the stock is expected to return 30%, 12% in a normal economy, and negative (20%) in a recessionary period. The probability of a recession is 15%. There is a 30% chance of a boom economy. The remainder of the time, the economy will be at normal levels. What is the overall expected value of the returns on Eagle Adventures, Inc. stock

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Willie · Answer 1

Expected Value of the return = 12.6%

Explanation:

The expected rate of return is the weighted average of all the possible returns associated with an investment decision. The returns are weighted using the probability associated with their outcomes.

Expected return = WaRa + Wb+Rb + Wn+Rn

W - weight of the outcome, R - return of the outcome

W - Probability of the expected outcome, R - expected return under a circumstance

The probability of having a normal economy

Note that the sum of the probability of different outcomes should equal to one. Hence, the probability of economy being normal is

= 100% - (15%+30%) = 55%.

Expected Value of the return

(0.3 * 30%) + (0.55 * 12%) + (0.15 * - 20%) = 0.126

=0.126 * 100

= 12.6 %

Expected Value of the return = 12.6%