Question

A Company has to make a choice between two strategies:
Strategy 1: expected to result in a market price now of $100 per share of common stock and a price of $120 five years from now.
Strategy 2: expected to result in a market price now of $80 and a price of $140 five years from now.
What do you recommend? Assume that all other things are unaffected by the decision being considered.

Answer 1

Going by the assumption that all other things are unaffected by the decision being considered and all the other things remaining constant, the main goal for any organization is to maximize its shareholders’ wealth in the long run. As a general rule under Modern Finance theory, investors prefer to receive more ‘expected’ return than less ‘expected’ return in future.

Second thing that turns the choice in favour of Strategy 2 is the rate of return. In strategy 1, the growth is only $20, over a base of $100, which is only 20% return (not annualized) received over 5 years.

Whereas, under strategy 2, it’s a growth of $60, over base of $80, which is close to 75% return (not annualized) received over a period of 5 years.

The above 2 reasons makes Strategy 2 a better alternative than Strategy 1.