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 15 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.)
To calculate the profit for both Firm A and Firm B, we need to consider the revenue, the variable costs, and the fixed costs.
1. Revenue:
Both firms sell 10,000 units of output at $2.50 per unit. Therefore, the revenue for each firm can be calculated as follows:
Revenue = Number of units sold × Price per unit
Revenue = 10,000 units × $2.50 per unit
Revenue = $25,000
So the revenue for both Firm A and Firm B is $25,000.
2. Variable Costs:
The variable costs of production per unit are $1. Therefore, the total variable costs for each firm can be calculated as follows:
Variable Costs = Number of units sold × Variable cost per unit
Variable Costs = 10,000 units × $1 per unit
Variable Costs = $10,000
So the variable costs for both Firm A and Firm B are $10,000.
3. Fixed Costs:
The fixed production costs are given as $12,000 for both firms.
Now, let's calculate the profit for each firm:
For Firm A:
Profit = Revenue - Variable Costs - Fixed Costs
Profit = $25,000 - $10,000 - $12,000
Profit = $3,000
For Firm B:
To calculate the profit for Firm B, we need to find the interest expense on the debt. The interest expense is given as 15% of $5,000, which is:
Interest Expense = Debt × Interest Rate
Interest Expense = $5,000 × 0.15
Interest Expense = $750
Now, we can calculate the profit for Firm B:
Profit = Revenue - Variable Costs - Fixed Costs - Interest Expense
Profit = $25,000 - $10,000 - $12,000 - $750
Profit = $2,250
Therefore, the profit for Firm A is $3,000 and the profit for Firm B is $2,250.