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Foundations Of Financial Management
Found in: Page 49
Foundations Of Financial Management

Foundations Of Financial Management

Book edition 16th
Author(s) Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen
Pages 768 pages
ISBN 9781259277160

Short Answer

Lemon Auto Wholesalers had sales of $1,000,000 last year, and cost of goods sold represented 78 percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation expense was $11,000 and interest expense for the year was $8,000. The firm’s tax rate is 30 percent.

a. Compute earnings after taxes.

b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 14 percent of sales, sales can be increased to $1,050,900. The extra sales effort will also reduce cost of goods sold to 74 percent of sales. (There will be a larger markup in prices as a result of more aggressive selling.) Depreciation expense will remain at $11,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to $15,800. The firm’s tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas increase or decrease profitability?

  1. Earnings after taxes: $56,700
  2. Earnings after taxes: $69,516

The profitability of the company increases after following the idea of Ms. Carr.

See the step by step solution

Step by Step Solution

Calculation of earnings after tax

Sales

$1,000,000

Less: Cost of sales (78% of sales)

780,000

Gross profit

220,000

Less: Selling and administrative expenses (12% of sales)

120,000

Less: Depreciation expense

11,000

Operating profit89,000

Less: Interest expenses

8,000

Earnings before tax

81,000

Less: Tax expense ($81,000 x 30%)

24,300

Earning after tax

56,700

Calculation of earnings after tax when the idea of Ms. Carr is followed

Sales

$1,050,900

Less: Cost of sales (74% of sales)

777,666

Gross profit

273,234

Less: Selling and administrative expenses (14% of sales)

147,126

Less: Depreciation expense

11,000

Operating profit115,108

Less: Interest expenses

15,800

Earnings before tax

99,308

Less: Tax expense ($120,326 x 30%)

29,792

Earning after tax

69,516

Profitability will increase after following Ms. Carr's ideas.

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