Problem 20-01 Firm A has $10,500 in assets entirely financed with equity. Firm B also has $10,500 in assets, but these assets are financed by $5,250 in debt (with a 12 percent rate of interest) and...

Problem 20-01

Firm A has $10,500 in assets entirely financed with equity. Firm B also has $10,500 in assets, but these assets are financed by $5,250 in debt (with a 12 percent rate of interest) and $5,250 in equity. Both firms sell 14,000 units of output at $2.70 per unit. The variable costs of production are $1, and fixed production costs are $10,000. (To ease the calculation, assume no income tax.)

1. 
   

   What is the operating income (EBIT) for both firms? Round your answers to the nearest dollar.

   
   

   Firm A: $

   
   

   Firm B: $

   
   


2. 
   

   What are the earnings after interest? Round your answers to the nearest dollar.

   
   

   Firm A: $

   
   

   Firm B: $

   
   


3. 
   

   If sales increase by 20 percent to 16,800 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 partb. Round your answers to one decimal place.

   
   

   Firm A:   %

   
   

   Firm B:   %

   
   


4. 
   

   Why are the percentage changes different?

   
   

   The answers differ because Firm A uses  while Firm B uses  . The successful use of  magnifies the percentage increase in earnings when sales expand.