Question

Problem 20-01 Firm A has $9,200 in assets entirely financed with equity. Firm B also has $9,200 in assets, but these assets are financed by $4,600 in debt (with a 10 percent rate of interest) and $4,600 in equity. Both firms sell 11,000 units of output at $3.00 per unit. The variable costs of production are $1, and fixed production costs are $14,000. (To ease the calculation, assume no income tax.) a. What is the operating income (EBID for both firms? Round your answers to the nearest dollar Firm A:$ Firm B:$ b. What are the earnings after interest? Round your answers to the nearest dollar Firm A:$ Firm 8: c. If sales increase by 15 percent to 12,650 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. Round your answers to one decimal place. Firm A: Firm B: d. Why are the percentage changes different? The answers differ because Firm A uses Select earnings when sales expand while Firm B uses-Select- 이 . The successful use of「 -Select- magnifes the percentage increase in

Answer 1

20. a. EBIT of Firm A = 11000*(3-1) -14000 = 8000
   EBIT of Firm B = 11000*(3-1) -14000 = 8000

b. Earnings after Interest for A = EBIT - Interest = 8000 - 0 = 8000
  Earnings after Interest for B = EBIT - Interest = 8000 - 4600*10%= 7540

c. New Earnings after interest  of A =12650*(3-1) -14000 = 11300
Percentage change of Earnings after interest  of A =(11300-8000)/8000 = 41.25%
New Earnings after interest  of B =12650*(3-1) -14000 - 4600*10% = 10840
Percentage change of Earnings after interest  of A =(10840- 7540)/7540= 43.77%

d. Firm A uses equity and Firm uses debt or leverage. The successful use of debt magnifies the percentage increase in earnings when sales expand.

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