Firm A has 10,000 in assests entirely with equity. Firm b also has 10,000 in ass

Question

Firm A has 10,000 in assests entirely with equity. Firm b also has 10,000 in assets but these assests are financed by 5,000 in debt ( with a 10percent rate of intrests) and 5,000 in equity. Both firms sell 10,000 units of output at $2.50 percent

The variable costs of production costs are 12,000 (assume no tax)

A) What is the operating income EBIT for both firms?

B) What are the earnings after intrest?

C) If sales increase by 10 percent to 11,000 units, by what percentage will each firms earnings after intrest increase? to determine the earnings after taxes and compute the percentage increase in these earnings from the answers you derived from paert B

D) Why are the percentages changes differnt?

Explanation / Answer

1.Sales Revenue = 10000*2.5=25000
Variable cost = 10000*1=10000
Fixed cost = 12000
EBIT= sales/revenue – variable cost – fixed production cost

25000-10000-12000=3000

2. Firm A Firm B
Interest=0 Interest= 5000*10%=500
Earnings after tax=3000 Earnings after tax=2500

3. Sales Revenue = 11000*2.5=27500
Variable cost = 11000*1=11000
Fixed cost = 12000
EBIT=27500-11000-12000=4500

Firm A Firm B
Interest=0 Interest= 5000*10%=500
Earnings after tax=4500 Earnings after tax=4000
% increase=(4500-3000)/3000*100=50% =(4000-2500)/2500=60%

4. Firm B had a higher increase in profit because they had a higher net % change and lowered their interest income through their debt financing.

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