Dear exparts, Please teach me the following question. Firms X and Y have identic

ID: 2810623 • Letter: D

Question

Dear exparts,

Please teach me the following question.

Firms X and Y have identical assets, sales, interest rates paid on their deft, tax retes, and EBIT. However, X uses more debt than Y. Which of the following statements is correct? Why is the reason?

a. X would have the higher net income.

b. We cannnot tell if X or Y would have higher or lower net income.

c. X would have the lower equity multiplier for use in the DuPont equation.

d. X would have to pay more in income taxes.

e. X would have the lower net income as shown on the income statement.

Explanation / Answer

Lets take an example according to the information given to understand this question.

COMPANY X

COMPANY Y

Assets = $10,00,000

Debt = $4,00,000

Debt= $2,00,000

Equity= $ 6,00,000

Equity= $ 8,00,000

Sales = $5,00,000

Interest rate= 10%

Interest Rate= 10%

Tax rate = 50%

Tax rate= 50%

EBIT =$ 3,00,000

EBIT= $3,00,000

Calculation of Net Income (EAT) of Company X

PARTICULARS

AMOUNT

EBIT

3,00,000

(-) Interest [10% of 4,00,000]

(40,000)

=EBT

=2,60,000

(-)Tax [ 50% of 2,60,000]

(1,30,000)

= Net Income

= 1,30,000

Calculation of Net Income of Company Y

PARTICULARS

AMOUNT

EBIT

3,00,000

(-) Interest [ 10% of 2,00,000]

(20,000)

= EBT

=2,80,000

(-) Tax [ 50% of 2,80,000]

(1,40,000)

= Net Income

=1,40,000

Equity Multiplier = Total Assets/ Equity

Company X = 10,00,000/6,00,000 = 1.66

Company Y = 10,00,000/8,00,000 = 1.25

Therefore, according to the above information only option e only holds true that X has a lower net income as given in the income statement.

Hope this was easy and understandable :)