Firm A has $10,000 in assets entirely financed with equity. Firm B also has $10,

ID: 2697988 • Letter: F

Question

Firm A has $10,000 in assets entirely financed with equity. Firm B also

has $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 production

are $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 firmâ€™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

d. Why are the percentage changes different?

a) sals revenue = 10000 * 2.5 =25000

variablecost = 10000

fixed cost = 12000

EBIT = 25000 - 10000-12000 = 3000

b)firm A

interest =0%

earnings after interest= 3000

firm B

interest =10% * 5000 = 500

earnings after interest = 2500

c) EBIT=27000 -11000 - 12000 = 4500

for firm A

earnings after interest = 4500

%increase = 4500-3000/3000 * 100 = 50%

for firm B

earnings after interest = 4000

%increase = 4000-2500/2500 * 100 = 60%

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