Question 1: Aerotech, an aerospace-technology research firm, announced this morning that it has hired the world's most knowledgeable and prolific space researchers. Before today, Arotech's stock had been selling for $100. Assuming that no other information is received over the next week and the stock market as a whole does not move.
a. What do you expect will happen to Aerotech's stock?
b. Consider the following scenarios:
1. The stock price jumps to $118 on the day of the announcement. In subsequent days it floats up to $123, then falls back to $116.
2. The stock price jumps to $116 and remains at that level.
3. The stock price gradually climbs to $116 over the next week.
Which scenario(s) indicate market efficiency? Which do not? Why?
Question 2. The Pan Fries Company just announced a new model of their cooker which will reduce cooking time and fat absorption. The price reaction of their stock is listed below. Calculate the abnormal return behavior and explain the behavior.
Day Rpf E(Rpf )
-3 .005 .006
-2 .002 .002
-1 -.003 -.004
0 .015 .005
1 .001 -.001
2 -.003 -.004
3 .000 .002
Question 3. Advanced Engineering is currently unlevered with 2,000 shares outstanding and assets valued at $50,000. The company expects operating income in the current period to be $6,000. Suppose that the company can exchange 400 shares of stock for $10,000 in debt paying 10% interest. From the standpoint of EPS, show that the exchange will be wise. Assume no taxes.
Question 4: Asquith and Mullins studied a sample of firms that either paid their first ever cash dividend or initiated a dividend after a 10 year period of no dividends. Healey, Palepu and Michaely, and Thaler and Womack found stock prices to fall when dividends are. Explain how these positive and negative stock price results fit with the dividend irrelevance argument of MM and the opposing effects of taxes and current income needs on stock price if future earnings are held constant.
Question 5: Cap Henderson owns Neotech stock because its price has been steadily rising over the past few years and he expects its performance to continue. Cap is trying to convince Widow Jones to purchase some Neotech stock, but she is reluctant because Neotech has never paid a dividend. She depends on steady dividends to provide her with income.