Question

1. In 2019, a year in which the firm’s revenue increased, the firm’s gross margin (gross profits/revenue) also increased but the firm’s operating margin (operating profit/revenue) decreased. What does this imply regarding the performance of the firm in 2019?

2. Your friend Bob won the lottery. Four months from today he will start receiving his first annual payments and these payments will continue forever. His first payment will be $100,000 and these annual payments will grow at 2%/year. If we assume the appropriate risk adjusted discount rate is 7%/year, what is the current value of your friend’s lottery winnings? Providing an accurate equation with all of the appropriate inputs will get full credit.

3. If a bond’s market rate increases after the bond is issued then the value of the bond would increase. Agree or disagree? Explain!

4. The firm’s forecasted future dividends per share (DPS) over the next five years are:

    DPS                DPS                 DPS                 DPS                 DPS

   Year 1             Year 2             Year 3             Year 4             Year 5

               $2.00                $2.60               $3.40               $4.00               $4.20

If you believe the growth rate in dividends after year 5 is 3%/year in perpetuity and the firm’s beta is 0.8, then provide and equation to value the stock (include the value of all inputs in your equation).

5. Describe in words what the CAPM (Capital Asset Pricing Model) measures? Define the inputs used in the model.

6. Why is the firm’s cost of raising debt capital (k_d) always less than the firm’s cost of raising equity capital (k_e)? Explain fully!

7. When estimating a firm’s WACC, the weight of equity is a necessary input. Provide a detailed specific description of how you would estimate the weight of equity used to estimate the firm’s WACC.

Answer 1

Answer 1

Since in the above firm Revenue and Gross profit margin has been increased but at the same time Operating Profir Margin has been decreased. It could be done due to following factors;

1.Gross profit margins are based on revenues but minus the cost of goods sold (COGS). But Operating profit margins are calculated, based on revenues but minus all of the operating costs except interest and taxes.Some times your GP margin can increase, while your operating profit margin decreases.

2. Reasons in Increasing the gross profit margin while decreasing the operating profit margin could be that the companyis not able to achive streamline daily operations. Maybe Company is not able to hire contractors instead of employees, or maybe company is not doing online marketing.

3. Both are expressed in percentages, let's understand them;

• Gross Profit Margin = (Gross Revenue - COGS) / Gross Revenue
• Operating Proft Margin = EBIT / Gross Revenue

4. The on the operating profit margin marketing, wages and all other operating expenses affets it(affected by all other areas of the business operations), unlike the gross profit margin. Where GP Margin is affected by the cost of making products.

5. All the other operating costs affect the operating profit margin and ultimately the net profits of the company. These costs include office lease and utilities, equipment staff and fulfillment costs.

6. There are an infinite number of possibilities that can increase operating costs and derease operating profit margins like the costs which we have discussed above.

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