Question

- Assume you are considering an investment costing $10,000, for which the future cash flows from owning the security depend on the state of the economy as estimated in this table. In any given year the, the investment could produce any one of three possible cash flows, depending on the particular state of the economy.

Given this information calculate:

1. Expected Cash Flow
2. Expected rate of return

State of the economy	Probability of the states	Cash flow from the investment	% Return (Cash Flow/Inv. Cost)
Economic Recession	20%	$1,000	10% ($1,000/$10,000)
Moderate Economic Growth	30%	1,200	12% ($1,200/$10,000)
Strong Economic Growth	50%	1,400	14% ($1,400/$10,000)

Answer 1

Solution :

A. The Expected Cash Flow = $ 1,260

B. The Expected Rate of Return = 12.60 %

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.