Question

On 3/7/2020, the following announcement was made: “Early today the Justice Department
reached a decision in the Acme Brick Inc. case. The former chief executive officer of Acme
Brick, Doug Stevens, has been found guilty of discriminatory practices in hiring. As a result,
for the next five years, Acme must pay $2 million each year to a fund representing victims of
Acme policies. Mr. Stevens was fired and was replaced with Marcus Lemonis.” Analysts
universally applauded Acme’s hiring of Lemonis.

True or False (Circle one). Investors should not buy shares of Acme Brick common stock
today (on April 7, 2020) because the litigation settlement reached with the Justice Department
last year will cause an abnormally low rate of return over the next five years.

Answer 1

The answer is ‘False’

Reason: It is a publicly available information to which the market responds immediately. Efficient Market Hypothesis (EMH) states that all relevant information is factored into the prices instantaneously. As a result, shares are traded at their fair market value.

The announcement was made on 3/7/2020. By the time investment is considered, after one month on April 7, 2020, the market has already discounted this information and prices have corrected accordingly, to the extend needed. Therefore, no further fall in prices is expected to be caused by this announcement.