Question

PLEASE MAKE IT IN EXCEL IF REQUIRED FOMULA EXAMPLE

What do you understand by the term market efficiency are markets efficient?

Can the book value of equity be negative? Can the market vaue of equity be negative?

Can the cost of debt be higher than the cost of equity give reason?

Answer 1

Market efficiency means how financial assets are reacting to the various information. According to Efficient market hypothesis, three types of market efficiency exist.

Three types of market efficiency exist

1. Weak form: Assets are priced according to the past information
2. Semi- strong: Asset price reacts immediately to news that are available in public domain
3. Strong: Asset prices reacts immediately to the insider news and all the available information

A market can be said fully efficient if strong form of efficiency exists in the market

2) book value of equity = total asset - total liabilities - preferred equity

                                                 = Shareholder’s equity – preferred shares equity

• Book value of equity can become negative when Assets are less than liability or assets are decreasing faster than liability
• Book value can become negative when company is making losses and reserve and surplus become negative and outweighs paid-up capital.

Shareholder’s equity = Share capital + reserve and surplus (Leaving other items like treasury stock and preferred stocks etc.)

3) Market value of equity = share price x No of share

Market value of equity can never be negative, because the minimum share price can be 0 and number of share will always be a positive number. So, minimum possible value is zero.

4) In general, Cost of equity is higher than cost of debt because

• Debt are secured
• Debt holders are paid first than equity holders so equity are more risky

In rare cases cost of debt can become higher e.g. company has very low or negative beta.

Ke = Rf + beta * (Rm- Rf).