Problem 2 A friend of yours that owns some shares of Lala Ltd is considering selling...

Transcribed Image Text:

Problem 2 A friend of yours that owns some shares of Lala Ltd is considering selling her stake. Before acting she asked you to help her with the decision. She provides you with the financial statements of Lala Ltd. from the previous year. By analyzing the statements, you determine the following information system: Financial Statement Information State of Nature High (H) Low (L) GN 0.8 0.1 BN 0.2 0.9 Your friend assesses that the probability of high state is 0.75 (prior probability). At the current market price, if she decides to sell her stocks, she could earn a payoff of $90. If, instead, she waits until the end of next quarter, her payoff will be $121 if the high state is realized, and $49 is the low state is realized. Your friend is risk averse with utility equal to the square root of the payoff. Required a. Lola Ltd. has just reported its earnings for the quarter. The net income before special items is up 10% (compared to the same quarter last year) and is above the analysts' consensus expectation. However, the report includes a special item loss that reduces the net income below the analysts' consensus expectation. Does the financial report show good news (GN) or bad news (BN)? Explain. b. Based on the report in point a). Should your friend sell or hold the stocks? (Show your computation). Problem 2 A friend of yours that owns some shares of Lala Ltd is considering selling her stake. Before acting she asked you to help her with the decision. She provides you with the financial statements of Lala Ltd. from the previous year. By analyzing the statements, you determine the following information system: Financial Statement Information State of Nature High (H) Low (L) GN 0.8 0.1 BN 0.2 0.9 Your friend assesses that the probability of high state is 0.75 (prior probability). At the current market price, if she decides to sell her stocks, she could earn a payoff of $90. If, instead, she waits until the end of next quarter, her payoff will be $121 if the high state is realized, and $49 is the low state is realized. Your friend is risk averse with utility equal to the square root of the payoff. Required a. Lola Ltd. has just reported its earnings for the quarter. The net income before special items is up 10% (compared to the same quarter last year) and is above the analysts' consensus expectation. However, the report includes a special item loss that reduces the net income below the analysts' consensus expectation. Does the financial report show good news (GN) or bad news (BN)? Explain. b. Based on the report in point a). Should your friend sell or hold the stocks? (Show your computation).

Answer rating: 100% (QA)

a To determine whether the financial report shows good news GN or bad news BN we need to compare the ... View the full answer