The ABC Company can undertake an investment that is economically desirable. It will adversely affect current earnings, but in management’s judgment will benefit future earnings. Management fears that the stock market will interpret the decrease in earnings as a sign of weakness and the common stock price will immediately go down as the lower earnings are reported. Management plans to describe the characteristics of the investment in the annual report and in meetings with security analysts. The company’s primary goal is to maximize the well-being of its stockholders.

a. What would a decrease in stock price as a result of the investment imply about the stock market?

b. What does the decrease in income as a result of the investment imply about the accounting measures?

c. Should the company undertake the investment?