Question

You are considering buying stock A. If the economy grows rapidly, you may earn 25 percent on the investment, while a declining economy could result in a 20 percent loss. Slow economic growth may generate a return of 6 percent. If the probability is 14 percent for rapid growth, 25 percent for a declining economy, and 61 percent for slow growth, what is the expected return on this investment?

Answer 1

The expected return on this investment is 2.16%.

Step-by-step explanation:

Please find the below for detailed explanations and calculations:

We have:

The expected return on the investment is equal to the total of Weighted Return of each economy scenario; in which Weighted Return of each economy scenario is based on the probability each economy scenario happens and is calculated as Expected return of the scenario x Possibility of the scenario.

Thus, weighted return of:

Rapid growth : 0.14 x 0.25 = 3.5%

Slow growth : 0.61 x 0.06 = 3.66%

Declining growth: 0.25 x -0.20 = -5%

=> Expected return on the investment = 3.5% + 3.66% - 5% = 2.16%.