"Equity Investments":Valuation of assets

C is correct. For a violation of the strong form of market efficiency to occur, the strategy based on fundamental analysis must achieve a net return higher than the net return of the passive strategy, on a risk-adjusted basis. This threshold corresponds to 15% because both strategies had the same systematic risk and the passive strategy has no fees or expenses. To find the gross return on the strategy that uses fundamental analysis, the fees and expenses must be added to the net return: Gross return = Net return + Fees and expenses = 15% + 2% = 17%. Anything in excess of 17% would violate the strong-form of market efficiency for the fundamental analysis strategy.

 A is incorrect. 18% erroneously uses the information provided in the table. In this example, it is simply the result of the addition of the net return and the fees and expenses of Strategy 2 and 3: 14% + 1% + 2% = 18%. 

B is incorrect. It uses as starting point the net return of the strategy that exploits price patterns (another active strategy, based on technical analysis) rather than the passive one: 14% + 2% = 16%. In order to claim a violation of the semi-strong-form of market efficiency, the strategy based on fundamental analysis has to outperform the passive strategy (net of fees and expenses), not the strategy based on technical analysis. Alternatively, 16% could also be found if the fees and expenses of Strategy 2, rather than Strategy 3, are used: 15% + 1% = 16%.

C is correct. Asset-based valuations work well for companies that do not have a high proportion of intangible or “off the books” assets and that do have a high proportion of current assets and current liabilities.

 A is incorrect because when a company has significant intangibles, the analyst should prefer a forward-looking cash flow valuation to an asset-based valuation model.

 B is incorrect because companies with assets that do not have easily determinable market (fair) values—such as those with significant property, plant, and equipment—are very difficult to analyze using asset-based valuation methods.