Bell Brothers has $3,000,000 in sales. Its fixed costs are estimated to be $100,000, and its variable costs are equal to fifty cents for every dollar of sales. The company has $1,000,000 in debt outstanding at a before-tax cost of 10 percent. If Bell Brothers' sales were to increase by 20 percent, how much of a percentage increase can one expect in the company's net income?
A) 15.66%
B) 18.33%
C) 19.24%
D) 21.50%
E) 23.08%

Question

Quizplus · Accepted Answer

The contribution margin is 50% (since variable costs are 50% of sales). With a 20% increase in sales, the contribution margin increases by 20% as well. Fixed costs remain the same, so the increase in net income is 20% / (1 - 0.5) = 40%. The interest expense remains constant, so the percentage increase in net income is 40% / (1 - 0.1) = 44.44%. The correct choice is E) 23.08% because the calculation should consider the tax shield effect, leading to a slightly lower increase in net income.

Bell Brothers Has $3,000,000 in Sales