Week 5 Individual Assignment FIN 370
Week 5 Individual Assignment
FIN 370
April 7, 2014
Problem: 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?
Company A
Company B
Sales
25,000.00
25,000.00
Variable Expenses
10,000.00
10,000.00
Fixed Costs
12,000.00
12,000.00
EBIT
3,000.00
3,000.00
b) What are the earnings after interest?
Company A
Company B
Sales
25,000.00
25,000.00
Variable Expenses
10,000.00
10,000.00
Fixed Costs
12,000.00
12,000.00
EBIT
3,000.00
3,000.00
Interest Expense
0.00
500.00
Taxes
0.00
0.00
Net Income
3,000.00
2,500.00
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.
Company A
Company B
Sales
27,500.00
27,500.00
Variable Expenses
11,000.00
11,000.00
Fixed Costs
12,000.00
12,000.00
EBIT
4,500.00
4,500.00
Interest Expense
0.00
500.00
Taxes
0.00
0.00
Net Income
4,500.00
4,000.00 percentage increase
50%
60%
d) Why are the percentage changes different?
At 10,000 units sold, both companies have the same earnings before interest and tax (EBIT) of $3,000.00. Company B incurs interest expense on $5,000.00 of debt at 10% = $500. Therefore, company A net earnings/income after interest and taxes is $3,000.00 and company B is $2,500.00. Increasing sales by 10% to 11,000 both companies increase their net earnings by $1,500.00. Because company B had a lower net earnings than
FIN 370
April 7, 2014
Problem: 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?
Company A
Company B
Sales
25,000.00
25,000.00
Variable Expenses
10,000.00
10,000.00
Fixed Costs
12,000.00
12,000.00
EBIT
3,000.00
3,000.00
b) What are the earnings after interest?
Company A
Company B
Sales
25,000.00
25,000.00
Variable Expenses
10,000.00
10,000.00
Fixed Costs
12,000.00
12,000.00
EBIT
3,000.00
3,000.00
Interest Expense
0.00
500.00
Taxes
0.00
0.00
Net Income
3,000.00
2,500.00
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.
Company A
Company B
Sales
27,500.00
27,500.00
Variable Expenses
11,000.00
11,000.00
Fixed Costs
12,000.00
12,000.00
EBIT
4,500.00
4,500.00
Interest Expense
0.00
500.00
Taxes
0.00
0.00
Net Income
4,500.00
4,000.00 percentage increase
50%
60%
d) Why are the percentage changes different?
At 10,000 units sold, both companies have the same earnings before interest and tax (EBIT) of $3,000.00. Company B incurs interest expense on $5,000.00 of debt at 10% = $500. Therefore, company A net earnings/income after interest and taxes is $3,000.00 and company B is $2,500.00. Increasing sales by 10% to 11,000 both companies increase their net earnings by $1,500.00. Because company B had a lower net earnings than
References: Mayo, H. B. (2012). Basic finance: An introduction to financial institutions, investments, and management (10th ed.). Mason, OH: South-Western. Retrieved from University of Phoenix eBook library.