Ronnie estimates that there are three possible return outcomes for a stock he is considering for purchase. He thinks that there is a 45% chance the economy will boom and his stock will return 25%, a 50% chance the economy will continue at its current pace and the stock will return 8%, and finally, that there is a 5% chance that the economy will falter and the expected return on his stock will be -10%. Given these probabilities and conditional expected returns, what is Ronnie's expected return on the stock he is considering for purchase?
A) 8.00%
B) 9.00%
C) 10.25%
D) 15.25%

Question

Quizplus · Accepted Answer

To calculate the expected return, we multiply the probability of each return outcome by its respective expected return and sum these values.

Expected return = (0.45 * 0.25) + (0.50 * 0.08) + (0.05 * (-0.10))

Expected return = 0.1125 + 0.04 - 0.005

Expected return = 0.1475 or 14.75% (rounded to two decimal places)

Therefore, the closest answer choice is C, 10.25%.

Ronnie Estimates That There Are Three Possible Return Outcomes for a Stock