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As an analyst for Whispering Inc

Finance Oct 23, 2020

As an analyst for Whispering Inc., you are responsible for many firms, including ADFC. Currently you have a "hold" recommendation on ADFC. The current price of ADFC is $149. You have conducted an extensive analysis of the industry and you feel that the probability the firm will capture a substantial share of the new market is 40 percent. If the firm is able to capture the new market, you are expecting earnings to grow at a rate of 45 percent per year for the next five years. In that case, the stock price would rise to $229 due to the unusually high growth rate of future earnings. However, you feel there is a 40-percent probability that the firm will face serious difficulties in the near future, in which case the stock price will fall to $109, and the earnings growth rate will drop to 3 percent. There is a 20-percent chance that nothing will change for the firm and its earnings growth rate will remain at 12 percent. 
Calculate the expected price in the future. (Round intermediate calculations to 4 decimal places, e.g. 31.2125 and final answer to 0 decimal places, e.g. 145.) 
Expected price 
Should you change your recommendation? 
The recommendation " be changed. 
 

Expert Solution

Probability of scenario 1 = 40% or 0.40

 

Intrinsic stock price under scenario 1 = $229

 

Probability of scenario 2 = 45% or 0.45

 

Intrinsic stock price under scenario 2 = $109

 

Probability of scenario 3 = 20% or 0.20

 

Intrinsic stock price under scenario 3 = $149

 

Probability weighted stock price = (probability of scenario 1 * intrinsic stock price under scenario 1) + (probability of scenario 2 * intrinsic stock price under scenario 2) + (probability of scenario 3 * intrinsic stock price under scenario 3)

 

Probability weighted stock price = 0.40*229 + 0.45*109 + 0.20*149

Probability weighted stock price = $170.45

 

As we can see that the new expected stock price is more than the current price

the recommendation should be changed.

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