World Cellfone Co. is considering the purchase of a new telecommunications syste

Question

World Cellfone Co. is considering the purchase of a new telecommunications system for $60millon. This system will boost the firm's productivit so that its operating earnings will increase by $12million per year over ther next 8 years. World Cellfone Co. corporate tax rate is35% and its debt and equity costs are 7% and 14%, respectively. The manufacturer of the telecommunication system is willing to loan the firm $25million for the purchase at a subsidized rate of 5%(with World Cellfone Co. putting up the remainder from its retained earnings account.) The loan principal is to ve paid off in 5 equal installments over 5 years with interset being paid every year on th loan outstanding. If the firm's required rate of return under all-equity financing is 10%, should it go ahead with the purchase??

Which of the following observations appear to indicate market inefficiency? Explain whether the observation appears to contradict the weak, semistrong, or strong form of the inefficient-market hypothesis.

a.       Tax exempt municipal bonds to offer pretax returns than taxable government bonds.      

b.      Managers make superior returns on their purchases of their company

Explanation / Answer

c.       There is a positive relationship between the return on the market in one quarter and the change in aggregate profits in the next quarter.

e.       The stock of an acquired firm tends to appreciate in the period before the merger announcement.

g.      Very risky stocks on average give higher returns than safe stocks.

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