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6_FIN 370 Chapter 20 Problem 1 Week 5
$ 10.00

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 production are $1, and fixed production costs are $12,000. (To
ease the calculation, 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’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.

d. Why are the percentage changes different?

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