A probability-weighted forecast is not a promise
Series XV case study · set 3, case 5 of 5 · 4 questions · 1 mark each
Question 1 of 4Case practice
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The case · stays here for all 4 questions
An analyst builds three mutually exclusive one-year scenarios for a fictional company: bear-case EPS ₹8 with probability 25%, base-case EPS ₹12 with probability 50%, and bull-case EPS ₹20 with probability 25%. For simplicity, the terminal P/E is assumed to be 15 in every scenario. The current share price is ₹200, and no dividend is expected during the year. The analyst is asked to show the probability-weighted price and expected simple price return. A colleague wants to publish only the bull-case price as a certain target. Probabilities and valuation multiples are explicit assumptions, not measured guarantees, and the report should communicate that uncertainty.
All people, firms, prices and contract terms are fictional.
Ignore taxes and transaction costs unless the case explicitly includes them.
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The case and its answers
Every question of this case, with its answer and why each other option is wrong.
An analyst builds three mutually exclusive one-year scenarios for a fictional company: bear-case EPS ₹8 with probability 25%, base-case EPS ₹12 with probability 50%, and bull-case EPS ₹20 with probability 25%. For simplicity, the terminal P/E is assumed to be 15 in every scenario. The current share price is ₹200, and no dividend is expected during the year. The analyst is asked to show the probability-weighted price and expected simple price return. A colleague wants to publish only the bull-case price as a certain target. Probabilities and valuation multiples are explicit assumptions, not measured guarantees, and the report should communicate that uncertainty.
All people, firms, prices and contract terms are fictional.
Ignore taxes and transaction costs unless the case explicitly includes them.
Q1What is probability-weighted EPS?
Option A. ₹13 — Correct answer
Option B. ₹13.33
Why it is wrong: This gives equal weights to all three scenarios.
Option C. ₹12
Why it is wrong: This is only the base-case EPS.
Option D. ₹20
Why it is wrong: This is only the bull case.
Answer: A. 0.25 × ₹8 + 0.50 × ₹12 + 0.25 × ₹20 = ₹13. Remember: Expected values use the scenario probabilities rather than an unweighted average.
Hint, shown before you answer in practice mode: Weight each outcome by its specified probability.
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Q2What is the probability-weighted terminal price under the common P/E assumption?
Option A. ₹300
Why it is wrong: This is only the bull-case price.
Option B. ₹200
Why it is wrong: This is the current market price, not the scenario-weighted estimate.
Option C. ₹195 — Correct answer
Option D. ₹180
Why it is wrong: This values only the base-case EPS.
Answer: C. ₹13 × 15 = ₹195. Equivalently, weight the three scenario prices ₹120, ₹180 and ₹300. Remember: A common linear valuation multiple can be applied after probability weighting.
Hint, shown before you answer in practice mode: With the same multiple in every scenario, multiply weighted EPS by 15.
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Q3What expected simple price return follows from the ₹200 current price?
Option A. −10.00%
Why it is wrong: This uses only the base-case price.
Option B. 2.50%
Why it is wrong: This reverses the sign of the expected price difference.
Option C. −2.50% — Correct answer
Option D. 50.00%
Why it is wrong: This uses only the bull-case price.
Answer: C. (₹195/₹200 − 1) × 100 = −2.50%. No dividend is included because the case specifies none. Remember: Expected return and the most optimistic scenario are different quantities.
Hint, shown before you answer in practice mode: Compare the weighted terminal price with the starting price.
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Q4How should the proposed “certain” bull-case target be handled?
Option A. Publish ₹300 as guaranteed because it is mathematically possible.
Why it is wrong: Possibility is not certainty, and its assigned probability is only 25%.
Option B. Claim the ₹195 weighted value must occur exactly.
Why it is wrong: An expected value need not equal any realised outcome.
Option C. Delete the bear case without changing the stated probabilities.
Why it is wrong: That would conceal a modelled downside and break the complete scenario presentation.
Option D. Present it as one conditional scenario and disclose the alternative outcomes and assumptions. — Correct answer
Answer: D. The bull case is one possible outcome, while ₹195 is a probability-weighted estimate. Neither is a promise of the future market price. Remember: Research should communicate the range and conditional nature of model outcomes.
Hint, shown before you answer in practice mode: Distinguish a scenario, an expected value and a guaranteed outcome.
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