1. Firm A has $10,000 in assets entirely financed with equity. Firm B also has $
ID: 2708024 • Letter: 1
Question
1. 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 produc-tion are $1, and fixed production costs are $12,000. (To ease the calcula-tion, 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
Explanation / Answer
a) total revenue from sales = 10,000*$2.5 = 25000
total cost = $12000 + (1*10,000) = 22000
EBIT for both the firms = $3000
b) after interest, earnings of firm A = $3000
after interest earninigs of firm B = $3000 - (0.1*5000) = $2500
c)if sales = 11,000 after interest, earnings of firm A = (11000 * 2.5) - (12000 + 1*11000) = $4500 % increase = 1500/3000 = 50%
firm B= $4500 - (0.1*5000) = $4000 % increase = 1500/2500 = 60%
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