In finance, one theory that is commonly discussed in MBA programs is the efficient market hypothesis (EMH). The EMH theory states that financial markets are “informationally efficient,” meaning that all publicly available information is quickly and accurately reflected in asset prices.
However, when it comes to applying the EMH theory in practice, there are many real-world examples that challenge this hypothesis. For instance, consider the case of insider trading, where individuals with access to non-public information can profit from buying or selling stocks before the information becomes public. This type of behavior suggests that financial markets may not always be perfectly efficient, as the EMH theory would predict.
Another example of theory and application in finance is the Capital Asset Pricing Model (CAPM). The CAPM theory states that the expected return on an investment can be calculated as the risk-free rate plus a premium for the additional risk taken on by investing in that specific asset. In practice, however, the CAPM model has been criticized for its oversimplification and inability to accurately predict returns in real-world scenarios. Nevertheless, despite its limitations, the CAPM remains a widely used tool in finance and is often discussed in MBA programs as a starting point for understanding modern portfolio theory and asset pricing.
One other practical example of finance in a real organization is the use of discounted cash flow (DCF) analysis. A company may use DCF analysis to evaluate a potential investment opportunity and determine its expected return. For example, let’s say a company is considering investing in a new manufacturing plant. The company would first estimate the cash flows generated by the plant over a certain period of time, typically several years. Then, it would discount these cash flows to present value, taking into account the cost of capital and the time value of money. Finally, the company would compare the present value of the cash flows to the cost of the investment to determine if the investment would be economically viable. In this way, DCF analysis helps the company make informed investment decisions based on a rigorous financial analysis of the expected returns.
