BB3

A particular firm’s shareholders demand a 15 percent return on their investment, given the firm’s risk. However, this firm has historically generated returns in excess of shareholder expectations, with an average return on its portfolio of investments of 25 percent.

a.   Looking back, what kind of stock-price performance would you expect to see for this firm?

b.   A new investment opportunity arises, and the firm’s financial analysts estimate that the project’s return will be 18 percent. The CEO wants to reject the project because it would lower the firm’s average return and therefore lower the firm’s stock price. How do you respond?