Chapter 20 Problem 1

Week 5 Financing Strategy Problem Problem 1 Chapter 20 truehearted 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 avocation) and $5,000 in equity. Both firms sell 10,000 units of output at $2. 50 per unit. The variable comprises of production are $1, and fixed production bes are $12,000. (To unbosom the calculation, assume no income tax. ) A. What if the operating income (EBIT) for both firms? Sales/Revenue 10000 * 2. 50 = 25000 Variable salute 10000 * 1 = 10000 Fixed Production constitute 12000EBIT = gross revenue/revenue variable cost fixed production cost = 25000 10000 12000 = $3000 B. What are the earnings after bet? InterestEarnings after interest Firm A 0 3000 0 = $3000 Firm B5000 * 10% = 500 3000 500 = $2500 C. If sales attach by 10 percent to 11,000 units, by what piece will each firms 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. Sales/Revenue 11000 * 2. 50 = 27500 Variable Cost 11000 * 1 = 11000Fixed Production Cost 12000 EBIT = sales/revenue variable cost fixed production cost = 27500 11000 12000 = 4500 Firm A Firm B Interest 05000 * 10% = 500 Earnings after interest (prior) 3000 0 = 3000 3000 500 = 2500 Earnings after interest (after) 4500 0 = 4500 4500 500 = 4000 Increase/decrease % 50% 60% D. Why are the percentage changes different? Firm B had a higher increase in profit because they had a higher net % change and lowered their interest income through their debt financing.