- 9 Marks
FM – L2 – Q19 – Financial markets
Question
A company’s board of directors makes a decision on 1st May to invest in a new project that will have an NPV of + GH₵4,000,000. The decision is announced to the stock market on 12th May.
The company has 50 million shares in issue and at close of trading on 30th April these had a market value of GH₵4 each.
Required:
(A). State what would happen to the share price of the company if the stock market has weak form efficiency
(B) State what would happen to the share price of the company if the stock market has semi-strong form efficiency.
(C). State what would happen to the share price of the company if the stock market has strong-form efficiency.
Answer
(A). The share price will not react to the announcement by the directors. Share prices in a market with weak-form efficiency react to historical data, not future expectations.
(B). If investors believe the estimate of an NPV of + GH₵4,000,000, the value of the company’s shares will increase by this amount (GH₵0.08 per share) to rise to GH₵4.08 on 12th May – the date that the announcement is made by the market.
(C). If investors believe the estimate of an NPV of + GH₵4,000,000, the value of the company’s shares will increase by this amount (GH₵0.08 per share) to rise to GH₵4.08 on 1st May – the date that the investment decision is taken and before it is formally announced to the market.
- Tags: Efficient markets, NPV announcement, share price, Stock market, Strong form efficiency
- Level: Level 2
- Topic: Financial markets
- Uploader: Samuel Duah