CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

Assume that net sales are increasing faster than the rate of inflation, and that the company's gross profit rate is falling. The most likely explanation is that ______

A. the company's cost of purchasing merchandise is falling.
B. operating expenses are rising.
C. demand for the company's products is very strong.
D. the company has achieved an increase in sales volume by reducing its sales prices.
Correct Answer: D

User Contributed Comments 19

User Comment
Gina D because gross profit rate= (NSales-COGS)/NSales
Excluding inflation, rate will only decline if COGS increases, and that will be the case if you sell a larger volume at a lower price.

COGS is part of operating expenses, but answer D is more specific? I guess.
synner net sales are bigger, to make profit rate fall, profit has to fall, because cost is not changing, so the price has to fall?
yanpz I don't think the anwer is correct. Net Sales is the dollar value of sales revenue, not the amount of sold products. I would select B.
yanpz On second thought, when price reduce, more units are sold, then COGS should increase... so D is possible too, as well as B.
Done One could say that prices have not kept up with inflation which explains the lower prices, operating expenses are fixed and/or variable cost are controlled so profit margins would fall because of inflation and the lower prices. "D"

OR

Prices have not kept up with inflation i.e. lower prices and the cost to do business has increased because of inflation i.e. operating expenses, so profit margins have fallen even if sales volume has increased, so "B" could be the answer.
treakj Discounts should be included in COGS
krisscfa Increase in Inflation casues increase in Prices.....If prices increase sales shud obviuosly decrease.....contrary to this the sales have infact increased....one of the possible reasons cud be the company has sold the goods at a discount.....and thts hw the GP margin came down.....
stevens sales can increase, even if there is inflation. sales can increase because larger ad budgets, competition, and many other reasons, or even the prices of all merchandises are increasing. Based on the conditions in the question D is the most likely answer.
surob B cannot be the answer because GP = Net Sales - COGS. It doesn't include operating expenses. Operating expenses is below GP, usually called SG&A.
hannovanwyk Surob is right, operating expenses has nothing to do with COS...its only calculated below.
robB surob and hannovanwyk are right. Gross Profit Margin has nothing to do with operating expenses only COGS..the answer must be D..none of the others are even close
RCapistrano Gross Profit (GP) Rate/Margin = [Sales - COGS] / Sales

Nothing is method about COGS in any of the answer choices so we can only look at the components of Sales, which are Price and Quantity.

There is no mention of demand or production increase so that leaves out "price". Price has to decrease for GP to decrease - this leaves with answer choice D.
magicchip Answer is D for the simple reason that it is stated that Net Sales are up. The reason for Net Sales to be up is more likely than not a drop in the price.
dravinskis Be careful in the real world as some companies list their COGS as "Operating expenses" and then the SG&A separately below. It can be quite confusing compared to what the "norm" should be.
thekobe put attention at the word gross profit! operating profit is beyond that
Shaan23 Smart to split the equation GP Margin = 1 - COGS/Revenue

R goes down ---> GP margin falls
COGS goes up ----> GP margin falls

D) Sales volume increases so COGS goes up a La De Da!
Shaan23 Actually not La De Da.

If sales volume increases due to a decrease in sales price we dont know which way Revenue is going(Up or Down). Since we dont know which way it's going how can we conclude D.

COGS goes up -- thats correct....But Revenue is a part of the equation as well...

Anybody?
Shaan23 Nevermind....First sentenece answered my question. Net sales are increasing.

so yeah. La De Da.
rabihCH If operating expenses rise, this will not increase net sales beyond inflation as price in market is still the same (increasing only with inflation value), though it will reduce gross margin. Hence NOT B.
If price is reduced then sales increase (supply/demand trends) and gross margin is reduced. Hence D.
You need to log in first to add your comment.