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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