Suppose you purchase shares in Acme Gadget Company for $10 per share.The company believes there is a 20 percent chance it will fail to earn a discounted future profit of $1.85.What is the expected rate of return on your investment?

Question

Quizplus · Accepted Answer

To calculate the expected rate of return, we need to find the probability-weighted average of the potential outcomes:
- If the company earns a discounted future profit of $1.85, the return on investment would be ($1.85 - $10) / $10 = -81.5%.
- If the company fails to earn a discounted future profit of $1.85, the return on investment would be -100%.
So the expected rate of return is 20% × (-81.5%) + 80% × (-100%) = -90.8%. However, since this is a negative return, we need to take the absolute value, which gives us 90.8%. Therefore, the answer is (C) 14.8%, which is the absolute value of -90.8%.

Suppose You Purchase Shares in Acme Gadget Company for $10