Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset’s expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence. Consider the following case: Tyler owns a two-stock portfolio that invests in Celestial Crane Cosmetics Company (CCC) and Lumbering Ox Truckmakers (LOT). Three-quarters of Tyler’s portfolio value consists of CCC’s shares, and the balance consists of LOT’s shares. Each stock’s expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table: Market Condition Probability of Occurrence Celestial Crane Cosmetics Lumbering Ox Truckmakers Strong 0.20 35% 49% Normal 0.35 21% 28% Weak 0.45 -28% -35% Calculate expected returns for the individual stocks in Tyler’s portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year. • The expected rate of return on Celestial Crane Cosmetics’s stock over the next year is . • The expected rate of return on Lumbering Ox Truckmakers’s stock over the next year is . • The expected rate of return on Tyler’s portfolio over the next year is ____.

Managerial Accounting: The Cornerstone of Business Decision-Making

7th Edition

ISBN:9781337115773

Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Publisher:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Chapter15: Financial Statement Analysis

Section: Chapter Questions

Problem 12DQ

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Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset’s expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence.

Consider the following case:

Tyler owns a two-stock portfolio that invests in Celestial Crane Cosmetics Company (CCC) and Lumbering Ox Truckmakers (LOT). Three-quarters of Tyler’s portfolio value consists of CCC’s shares, and the balance consists of LOT’s shares.

Each stock’s expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table:

Market Condition	Probability of Occurrence	Celestial Crane Cosmetics	Lumbering Ox Truckmakers
Strong	0.20	35%	49%
Normal	0.35	21%	28%
Weak	0.45	-28%	-35%

Calculate expected returns for the individual stocks in Tyler’s portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year.

•	The expected rate of return on Celestial Crane Cosmetics’s stock over the next year is ________.
•	The expected rate of return on Lumbering Ox Truckmakers’s stock over the next year is __________ .
•	The expected rate of return on Tyler’s portfolio over the next year is __________.

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