# Fin 370, Problem 1

Satisfactory Essays
Problem #1, Chapter 20
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?
Units sold*price per unit = Sales = 10000*2.5=25000
Units sold*Variable cost = Variable cost = 10000*1=10000
Fixed cost = 12000
Sales – Cost= EBIT=25000-10000-12000=3000 for both Firm A and Firm B
b. What are the earnings after interest?
Calculate interest and subtract it from EBIT to get earnings after interest.
Firm A: Interest=0; Earnings after interest=3000
Firm B: Interest= 5000*10%=500; 3000 – 500 = 2500; Earnings after interest=2500

c. If sales increase by 10 percent to 11,000 units, by what percentage will each firm's earnings after interest income increase? To answer the question, determine the earnings after taxed and compute the percentage increase in these earnings from the answers you derived in part b.
Units sold*price per unit = Sales = 11000*2.5=27500
Units sold*Variable cost = Variable cost = 11000*1=11000
Fixed cost = 12000
Sales – Cost = EBIT=27500-11000-12000=4500 for both Firm A and Firm B

Firm A: Interest=0 Earnings after tax=4500
Firm B: Interest= 5000*10%=500; 4500-500 = 4000; Earnings after tax = 4000

Percentage of increase equals difference in EBIT/EBIT in question a
Firm A = (4500-3000)/3000 = 50%
Firm B = (4000-2500)/2500 = 60%

d. Why are the percentage changes different?
The reason for the difference in percentage increase is the difference in interest. Even with a higher sales total, Firm A will have a lesser increase because there is no interest to deduct, which only changes the total by the units sold. Firm B, on the other hand, has

## You May Also Find These Documents Helpful

• Satisfactory Essays

Financial Terms and Definitions Your Name FIN/370 April 5, 2012 Professor Professor Name 1. Finance: Finance is the study of how people and businesses evaluate investments and raise capital to fund them. 2. Efficient market: Efficient market is the concept that all trading opportunities are fairly priced. 3. Primary market: Primary market is a part of the financial market where new security issues are initially bought and sold. 4.…

• 461 Words
• 3 Pages
Satisfactory Essays
• Satisfactory Essays

Syllabus School of Business FIN/370 Version 7 Finance for Business Copyright © 2012, 2011, 2010, 2008, 2006 by University of Phoenix. All rights reserved. Course Description This course introduces the student to the essential elements of finance for business. Emphasis is placed on financial management, financial markets, and the tools, techniques, and methodologies used in making financial decisions. Topics include: Financial planning, working capital management, capital budgeting, long-term…

• 1714 Words
• 7 Pages
Satisfactory Essays
• Satisfactory Essays

Financial Leverage Problem – due Mon March 4, 2013 Resource: Chapter 20, Mayo, H. B. (2012). Basic finance: An introduction to financial institutions, investments, and management (9th ed.). Mason, OH: Thomson. Firm A has \$20,000 in assets entirely financed with equity. Firm B also has \$20,000 in assets, financed by \$10,000 in debt (with a 10 percent rate of interest) and \$10,000 in equity. Both firms sell 30,000 units at a sale price of \$4.00 per unit. The variable costs of production…

• 388 Words
• 2 Pages
Satisfactory Essays
• Better Essays

1 Strategic Initiative Paper Walmart FIN/370 2 Strategic Initiative Paper Companies have to develop a plan both long term and short term. This is necessary for corporations so they are able to budget and know exactly what there goals are and how they plan to achieve them. They set target points and come up with methods to achieve the targets and goals. A company has to know who their competition is and how they plan to beat them and what methods they have to use in order to accomplish…

• 1264 Words
• 6 Pages
Better Essays
• Satisfactory Essays

Exam2 FIN370 Fall 2011 Key Version B 1. A call provision in a bond agreement grants the issuer the right to: A. repurchase the bonds prior to maturity at a pre-specified price. B. change the coupon rate provided the bondholders are notified in advance. C. replace the bonds with equity securities. D. buy back the bonds on the open market prior to maturity. E. call the bondholder to determine if he or she would like to extend the term of the bond agreement. BLOOMS TAXONOMY…

• 4083 Words
• 17 Pages
Satisfactory Essays
• Good Essays

Assessment of Hewlett Packard Ethics and Compliance HP has been noted to be one of the chief corporations in the area of computer technologies. Ethisphere Institute naming HP as one of the 2009 World’s Most Ethical Companies (HP Global Citizenship: Ethics and compliance, n.d.) was one of the companies latest accomplishments. HP had to make numerous in-house changes in order to acquire an ethical award brought about by ethical mishaps. Noted in Markkula Center (2007), HP unethical corporate conduct…

• 713 Words
• 3 Pages
Good Essays
• Satisfactory Essays

Definitions Steven Puryear Fin 370 10-6-2011 Mrs. Watson Definitions 1. Finance- The science of funds management. 2. Efficient Market- A market in which the values of all assets and securities at any instant in time fully reflect all available information, which results in the market value and the intrinsic value being the same. 3. Primary Market- A market in which new, as opposed to previously issued, securities are traded. The primary market provides the channel for sale of new…

• 376 Words
• 2 Pages
Satisfactory Essays
• Satisfactory Essays

willing to take for a promise of higher returns on investments. Keown, A. J., Martin, J. D., & Titman, S. (2014). Financial Management: Principles and Applications (12th ed.). : Pearson Education, Inc.. Agency (principal and agent problems) Refers to the problem companies face in motivating their managers who act as agents in pursuing the interests of the owners (shareholders). Keown, A. J., Martin, J. D., & Titman, S. (2014). Financial Management: Principles and Applications (12th ed.). : Pearson…

• 820 Words
• 3 Pages
Satisfactory Essays
• Satisfactory Essays

Nareekan Wongwisetsiri Finance 317 Financial Statements Homework #1 1. Watson Oil recently reported (in millions) \$8,250 of sales, \$5,750 of operating costs other than depreciation, and \$650 of depreciation. The company had \$3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to make \$1,250 of capital expenditures on new fixed…

• 517 Words
• 4 Pages
Satisfactory Essays
• Satisfactory Essays

FIN370 Week 2 Individual Assignment Chapter Study Questions 14.1 What are financial markets? What function do they perform? How would an economy be worse off without them? Financial markets are institutions and procedures that facilitate transactions in all types of financial claims. Financial markets perform the function of allocating savings in the economy to the ultimate demander(s) of the savings. Without these financial markets, the total wealth of the economy would be lessened. Financial…

• 430 Words
• 2 Pages
Satisfactory Essays