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Homework answers / question archive / If debt financing is used, which of the following is correct? a
If debt financing is used, which of the following is correct?
a. The percentage change in net operating income will be equal to a given percentage change in net income.
b. The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt.
c. The percentage change in net income will be greater than the percentage change in net operating income.
d. The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income.
e. The percentage change in net operating income will be greater than a given percentage change in net income.
Correct answer: Option c. The percentage change in net income will be greater than the percentage change in net operating income.
Explanation:
Net income is determined from income before taxes while net operating income is the income before considering the interest expense. When debt financing is used, the company has to pay interest on the debt-financed as a result of which, there will be a change in the net income though there will not be any change in EBIT as it is the income before interest and taxes. Hence, we can say that the percentage change in net income will be greater compared to the percentage change in the net operating income.
