Question

Explain how the efficient market hypothesis (EMH) may be inconsistent with the ideal of a positive NPV project.

Answer 1

Efficient market hypothesis (EMH) says that in an efficient market, no one should be able to earn super-normal profits consistently, thereby implyng that firms can only earn normal profits which is consistent with the riskiness of the project.

If a firm can only earn normal profits commensurate with the risk of the project (reflected through the discount rate), the NPV of a project can at best be 0.

So, Efficient market hypothesis (EMH) is inconsistent with the idea of positive NPV projects in this way