1.A Assume that a Peruvian company, DMB LLC, just reported its earnings this year. The reported revenue was $10 million and the reported cost was $9 million. The discount rate is 8%. Mark ALL the CORRECT statements. For this question, profit = revenue - cost. Hint: Apply the Gordon Formula to the profits of the firm. a) If the profit is expected to be constant, the present value of all the company's future profits is $125 million. b) If the profit is expected to grow 3% annually, the present value of all the company's future profits is $20 million. c) If the profit is expected to grow 4% annually, the present value of all the company's future profits is $25.75 million. d) If the profit is expected to grow 6% annually, the present value of all the company's future profits is $50 million.
1.A Assume that a Peruvian company, DMB LLC, just reported its earnings this year. The reported revenue was $10 million and the reported cost was $9 million. The discount rate is 8%. Mark ALL the CORRECT statements. For this question, profit = revenue - cost. Hint: Apply the Gordon Formula to the profits of the firm. a) If the profit is expected to be constant, the present value of all the company's future profits is $125 million. b) If the profit is expected to grow 3% annually, the present value of all the company's future profits is $20 million. c) If the profit is expected to grow 4% annually, the present value of all the company's future profits is $25.75 million. d) If the profit is expected to grow 6% annually, the present value of all the company's future profits is $50 million.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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![### Applying the Gordon Formula to Evaluate Future Profits
#### Question:
Assume that a Peruvian company, DMB LLC, just reported its earnings this year. The reported revenue was $10 million and the reported cost was $9 million. The discount rate is 8%. Mark ALL the CORRECT statements. For this question, profit = revenue – cost. Hint: Apply the Gordon Formula to the profits of the firm.
#### Calculation:
\[
\text{Profit} = \text{Revenue} - \text{Cost} = \$10 \text{ million} - \$9 \text{ million} = \$1 \text{ million}
\]
The Gordon Formula, or Gordon Growth Model, is given by:
\[
\text{Present Value (PV)} = \frac{D}{r - g}
\]
where \(D\) is the expected profit, \(r\) is the discount rate, and \(g\) is the growth rate of the profit.
#### Statements:
a) If the profit is expected to be constant, the present value of all the company’s future profits is $125 million.
b) If the profit is expected to grow 3% annually, the present value of all the company’s future profits is $20 million.
c) If the profit is expected to grow 4% annually, the present value of all the company’s future profits is $25.75 million.
d) If the profit is expected to grow 6% annually, the present value of all the company’s future profits is $50 million.
e) If the profit is expected to grow 10% annually, the present value of all the company’s future profits is negative.
### Explanation of Statements:
1. **Statement a:**
\[
\text{PV} = \frac{\$1 \text{ million}}{0.08 - 0} = \frac{\$1 \text{ million}}{0.08} = \$12.5 \text{ million}
\]
Therefore, this statement is **incorrect**.
2. **Statement b:**
\[
\text{PV} = \frac{\$1 \text{ million}}{0.08 - 0.03} = \frac{\$1 \text{ million}}{0.05} = \$20 \text{ million}
\]
Therefore, this statement is **correct**.
3](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F36d93af9-1c60-4c54-a265-7600bbfc6b68%2Faef3d0f5-9703-421d-8e0d-8e0ee9637312%2F89h2mx_processed.jpeg&w=3840&q=75)
Transcribed Image Text:### Applying the Gordon Formula to Evaluate Future Profits
#### Question:
Assume that a Peruvian company, DMB LLC, just reported its earnings this year. The reported revenue was $10 million and the reported cost was $9 million. The discount rate is 8%. Mark ALL the CORRECT statements. For this question, profit = revenue – cost. Hint: Apply the Gordon Formula to the profits of the firm.
#### Calculation:
\[
\text{Profit} = \text{Revenue} - \text{Cost} = \$10 \text{ million} - \$9 \text{ million} = \$1 \text{ million}
\]
The Gordon Formula, or Gordon Growth Model, is given by:
\[
\text{Present Value (PV)} = \frac{D}{r - g}
\]
where \(D\) is the expected profit, \(r\) is the discount rate, and \(g\) is the growth rate of the profit.
#### Statements:
a) If the profit is expected to be constant, the present value of all the company’s future profits is $125 million.
b) If the profit is expected to grow 3% annually, the present value of all the company’s future profits is $20 million.
c) If the profit is expected to grow 4% annually, the present value of all the company’s future profits is $25.75 million.
d) If the profit is expected to grow 6% annually, the present value of all the company’s future profits is $50 million.
e) If the profit is expected to grow 10% annually, the present value of all the company’s future profits is negative.
### Explanation of Statements:
1. **Statement a:**
\[
\text{PV} = \frac{\$1 \text{ million}}{0.08 - 0} = \frac{\$1 \text{ million}}{0.08} = \$12.5 \text{ million}
\]
Therefore, this statement is **incorrect**.
2. **Statement b:**
\[
\text{PV} = \frac{\$1 \text{ million}}{0.08 - 0.03} = \frac{\$1 \text{ million}}{0.05} = \$20 \text{ million}
\]
Therefore, this statement is **correct**.
3
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