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Financial Management EnvironmentSection BFinancial ManagementSyllabus BMarket Efficiency

ACCA · Question 17.4 · Financial Management Environment

CASE 2: AERODRONE TECH

AeroDrone Tech is an ungeared manufacturer of commercial delivery drones. The company currently has a cost of equity of 12%. The board is considering a major restructuring to issue debt and repurchase equity. The corporate tax rate is 25%. The risk-free rate is 4% and the equity risk premium is 6%.

If AeroDrone Tech decides to list on a stock exchange that exhibits semi-strong form efficiency, how will the share price react to the public announcement of the restructuring?

Answer options:

A.

The share price will slowly adjust over several weeks as investors analyze the news.

B.

The share price will adjust immediately and accurately to reflect the public announcement.

C.

The share price will only react if insiders trade on the information before the announcement.

D.

The share price will not react at all, as restructuring does not affect historical data.

How to approach this question

Recall the definitions of the Efficient Market Hypothesis (EMH). Semi-strong form means prices reflect all publicly available information instantly.

Full Answer

B.The share price will adjust immediately and accurately to reflect the public announcement.✓ Correct
According to the Efficient Market Hypothesis (EMH), a semi-strong form efficient market incorporates all publicly available information into share prices immediately and accurately. Therefore, as soon as the restructuring is publicly announced, the share price will adjust to reflect the new expected value of the firm. No investor can make abnormal returns by trading on this public news after it is released.

Common mistakes

Confusing semi-strong form with weak form (historical data) or strong form (insider information).
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