Consider a Stock with a 50 Percent Probability of Zero

question 327

Multiple Choice

Consider a stock with a 50 percent probability of zero net earnings and a 50 percent probability of net earnings equal to $20 per share each year continuously in the future. Furthermore, assume that people are risk averse. That is, they will have to be compensated for uncertainty accompanying variation in their future wealth. If the interest rate were 5 percent, how much would people be willing to pay for a share of this stock?

• A) $10
• B) $200
• C) less than $200
• D) more than $200
• E) $400

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Definitions:

Isoquant

A curve that represents all combinations of production factors that result in the production of a given level of output, in production theory.

Profit-Maximizing

The process of increasing a firm's profits to the highest possible level by adjusting output and pricing strategies.

Total Cost

The aggregate expenditure necessary to produce a given quantity of a product, summing up all costs, both fixed and variable, associated with production.

Isocost Line

A graph that shows all combinations of inputs that cost the same total amount for a firm.