FIN370 ch-20 week 5 Problem 1
1. Firm A has $10,000 in assets entirely financed with
equity. Firm B alsohas $10,000 in assets, but these assets are financed by
$5,000 in debt(with a 10 percent rate of interest) and $5,000 in equity. Both
firms sell 10,000 units of
output at $2.50 per unit. The variable costs of
productionare $1, and fixed production costs are $12,000. (To ease the
calculation,assume no income tax.)
a. What is the operating income (EBIT) for both firms?
b. What are the earnings after interest?
c. If sales increase by 10 percent to 11,000 units, by what
percentage
will each firm’s earnings after interest increase? To answer
the question,
determine the earnings after taxes and compute the
percentage
increase in these earnings from the answers you derived in
part b.
d. Why are the percentage changes different?
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