**FIN370 Chapter 20 Problem 1 Week 5**

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 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 part b.

d. Why are the percentage changes different?

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