## Description

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 firmâ€™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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