Financing Strategy Problem

Financing Strategy Problem

Lisa Andrews

FIN/370

May 23, 2013

John Scherzi

Financing Strategy Problem

a) What is the operating income (EBIT) for both firms?

The operation income for both firms is calculated

Sales = $10,000

Variable cost = $10,000

Fixed cost = $12,000

So the equation is:

$10,000 x 2.5 -$10,000 x $12,000 = $3,000 (EBIT for both firms)

b) What are the earnings after interest?

The earning for firm A is: $0 interest

The earning after interest is: $3000 because ($3000 – 0= $3000)

The earning for firm B is: $5000 x 10% =500

The earnings after interest is: $2,500 because ($3000-$500=$2,500)

c) If the sales increase by 10 percent to 11,000 units, by what percentage will each firm’s earnings after interest increase? To answer each question, determine the earnings after taxes and compute the percentage increase in these earnings from the answers you derived in part b.

Firm A has $0 interest earned and their earning after taxes are $4,500. So the percentage increase would be 50%. The way that I figured that is that the EBIT is $4,500. So the earning after the taxes would be: ($4500- $0=$4500). Then lastly the percentage increase would be ($4,500 - $3,000)/3000x10 =50%).

Firm B: has $500 of interest earned and their earnings after taxes would be $ 4,000. Which would make their percentage rate 60%. Interest earned = ($5,000 x 10% =$500). Then the earnings after taxes equation is: (4,500 -$500=$4000). Lastly the percentage increase equation: ($4,000-$2,500)/$2500= 60%)

d) Why are the percentage changes different?

The reason that that Firm A and Firm B percentage rates are different is because of the earnings after the taxes and the interest amounts in both companies.