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Determination of profitability

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Carr Auto Wholesalers had sales of \$900,000 in 2004 and their cost of goods sold represented 65 percent of sales. Selling and administrative expenses were 9 percent of sales. Depreciation expense was \$10,000 and interest expense for the year was \$8,000. The firm's tax rate is 30 percent.

"Earnings After Taxes (EAT) = Sales - Cost of Goods Sold = Gross Profit
Gross Profit - Selling and Administrative Expense - Depreciation = Operating Profit
Operating Profit - Interest Expense = Earnings Before Taxes
EBT - Taxes = EAT"

a. Compute earnings after taxes.
b. Assume the firm hires Ms. Hood, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 12 percent of sales, sales can be increased to \$1,000,000. The extra sales effort will also reduce cost of goods sold to 60 percent of sales (there will be a larger markup in prices as a result of more aggressive selling). Depreciation expense will remain at \$10,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to \$15,000. The firm's tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Hood's suggestions for Carr Auto Wholesalers.

c. Will her ideas increase or decrease profitability?
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Solution Preview

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Carr Auto Wholesalers had sales of \$900,000 in 2004 and their cost of goods sold represented 65 percent of sales. Selling and administrative expenses were 9 percent of sales. Depreciation expense was \$10,000 and interest expense for the year was \$8,000. The firm's tax rate is 30 percent.

"Earnings After Taxes (EAT) = ...

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