Provide Clear and Concise Answers.
1. (4 points) In 2017, 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 2017?
2. (4 points) If a bond’s market rate increases after the bond is issued then the value of the bond would increase. Agree or disagree? Explain!
3. (8 points) 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).
4. (5 points) Bondholders and stockholders have unique claims on the cash flows generated by the assets of the firm. After describing the claim of each investor group, explain how the differences in claims impacts the relative cost to the firm of raising money via debt (kd) and equity (ke)?
5. (5 points) Please respond to the following student question: From my understanding, unsystematic or firm specific risk is not rewarded. But if this is the case, why are some investors able to profit out of firm specific news?
6. (5 points) I am a board member for a swimming and health club in Bellevue. In the last fiscal year, the clubs membership was over 1600, the revenue was approximately $3.5 million, the profits were approximately $300,000, and their capital expenditures were close to $400,000. The stated objective or mission of this club is to increase the health and wellness of the club members and the community. In order to help the board assess the performance of the club’s director (CEO), what performance measures would you suggest? Explain your choice of performance measures!
7. (5 points) If you believe the stock market is semi-strong efficient, in very simple terms, explain what that means and also explain what causes the stock market to be semi-strong efficient.
8. (5 points) According to Value Based Management, why is it important to measure firm performance appropriately?
9. (4 points) In your opinion, what is the single most relevant traditional based performance measure? Explain your selection!
10. (4 points) How would a significant increase in bank debt (short term interest bearing liability) impact the measure of the firm’s Free Cash Flow? Explain!
11. (5 points) When we estimate Value Based performance measures to analyze a firm’s performance in their most recent fiscal year, we observed that the firm created value according to the estimate of Economic Value Added (EVA) but appeared to destroy value according to the estimate of Market Value Added (MVA). Could this be true? Explain!
12. (10 points) In 2017, a firm issued a significant amount of debt (bonds) and repurchased their equity (stock) with the funds raised from the debt offering (a debt for equity swap). The objective of this dramatic increase in leverage was to lower the firm’s WACC. Their analysis suggests that the firm’s WACC will decrease from 8% to 6% due to this debt for equity swap. Based on the Dupont model, how would this change in capital structure impact the firm’s future performance (profitability)? Does your response change if you use operating income versus net income to complete the Dupont analysis?
13. (6 points) Based on Value Based Performance measures (FCF, EVA, TSR), how would the change in the firm’s capital structure as described in question 12, impact the firm’s future performance?
