Suppose a company makes and sells bottles. The company can manufacture a million bottles every year (same number each year) at the cost of $6/bottle and sell them at the price of $10/bottle. Suppose there is no other cost, no taxes, and bottle prices never change, and that the company can always sell all the bottles it manufactures. Thus, the company makes $4 million profits each year.7 Further assume the company always pay out profits as dividends to shareholders.8Suddenly, the company experienced a surprising technology breakthrough which lowered the bottle production cost to $2/bottle. Assume this is the only change that happened. When this news was announced, the company’s stock price immediately jumped up by 50%.Does the market appear efficient? Why or why not?

The present share price of a company is the present value of all future dividends given by the company.so we have to calculate the share price of the company. The solution to the question is as follows: no of bottles company manufactures = 1MILLION cost of manufacturing = 6$/BOTTLE selling price =10$/BOTTLE profit per bottle =4$/BOTTLE Total profit to CO.= PROFIT PER BOTTLE×NO OF BOTTLE =4 × 1 =4 MILLION$ since the company gives out all the profit as dividends : dividend paid each year =4 million$ share price of a company is the present value of all future dividends. its calculated using the formula share price = dividend per year r after technology breakthrough, cost of manufacturing =2$/bottle selling price =10$/bottle profit per bottle =8$/bottle total profit = profit per bottle ×no of bottle = 8 × 1 = 8 million$ dividend paid each year =8 $million new share price = new dividend per year r since the dividend per year become double .the share price should also become double. this means share price should increase by100%. but the share price increases only by 50% ,which means that the market is not effecient.

Answered: Suppose a company makes and sells…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Suppose a company makes and sells bottles. The company can manufacture a million bottles every year (same number each year) at the cost of $6/bottle and sell them at the price of $10/bottle. Suppose there is no other cost, no taxes, and bottle prices never change, and that the company can always sell all the bottles it manufactures. Thus, the company makes $4 million profits each year.⁷ Further assume the company always pay out profits as dividends to shareholders.⁸

Suddenly, the company experienced a surprising technology breakthrough which lowered the bottle production cost to $2/bottle. Assume this is the only change that happened. When this news was announced, the company’s stock price immediately jumped up by 50%.

Does the market appear efficient? Why or why not?

Definition Definition Degree to which financial markets incorporate all available information into the prices of assets. In a more efficient market, the prices reflect the available information more than that in a weak efficient market. It is difficult for investors to outperform the market in a strong efficient market. This is because all the available information is already discounted in the asset's price. However, in a weak-form efficiency, the market does not reflect all information in the asset's price. As a result, it becomes easier to generate better returns in a weak form or an inefficient market.

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