November 2023 Chapter 20 Basic Finance Leverage Problem 1 A Firm A


Business & Finance

Chapter 20 Basic Finance:  Leverage / Problem 1

  1. A)   Firm A has $10,000 in assets entirely financed with equity. 
  2. B)  Firm B also has $10,000 in assets, but these are financed by $5,000 in debt

      (with a 10 % rate of interest) and $5,000 in equity.

  1. C)  Both firms sell 10,000 units of output at $2.50 per unit.
  2.  D)  The variable costs of production are $1.00, 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% 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 then compute the percentage increase in these earnings from the answers derived in part b.

d)      Why are the percentage changes different?