Question
In: Finance
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented here.
| Lenow | Hall | |||||
| Debt @ 9% | $ | 130,000 | Debt @ 9% | $ | 260,000 | |
| Common stock, $10 par | 260,000 | Common stock, $10 par | 130,000 | |||
| Total | $ | 390,000 | Total | $ | 390,000 | |
| Common shares | 26,000 | Common shares | 13,000 | |||
a. Complete the following table given earnings
before interest and taxes of $17,000, $35,100, and $58,000. Assume
the tax rate is 20 percent. (Negative amounts should be
indicated by parentheses or a minus sign. Round
your answers to 2 decimal places.)
b-1. What is the EBIT/TA rate when the firm's have
equal EPS?
b-2. What is the cost of debt?
b-3. State the relationship between earnings per
share and the level of EBIT.
c. If the cost of debt went up to 11 percent and
all other factors remained equal, what would be the break-even
level for EBIT?
Solutions
Expert Solution
a)
b-1) At $35,100 EBIT has equal EPS
EBIT/TA = (35,100 / 390,000)*100
= 9% Ans.
b-2) Cost of debt = Interest / Value of debt
= (130,000 * 9%) / 130,000
= 11,700 / 130,000 = 0.09 = 9% Ans.
b-3)
The 4.36 percent is before-tax return on assets, 9 percent, and 14.87 percent at the respective levels of EBIT. It appears that when the before-tax return on assets (EBIT/Total assets) is less than the cost of debt (9 percent), Lenow does well with less debt than Hall. However, when before-tax return to assets is equal to the cost of debt, both firms have equal EPS. This would be a result of the financing method having a neutral effect on EPS. As return on assets becomes greater than the interest rate, financial leverage becomes more favorable for Hall.
c.
At the EBIT break-even level:
EBIT / TA = Cost of debt
EBIT = Cost of debt × TA
= .09 × 390,000
= $35,100 Ans.
jeff jeffy answered 2 years agoRelated Solutions
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors
in the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here. Lenow Hall Debt @
9% $ 190,000 Debt @ 9% $ 380,000 Common stock, $10 par 380,000
Common stock, $10 par 190,000 Total $ 570,000 Total $ 570,000
Common shares 38,000 Common shares 19,000
a. Complete the following table given earnings before interest
and taxes of $23,000, $51,300, and $64,000. Assume the tax rate...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors
in the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here.
Lenow
Hall
Debt @ 10%
$
100,000
Debt @ 10%
$
200,000
Common stock, $10 par
200,000
Common stock, $10 par
100,000
Total
$
300,000
Total
$
300,000
Common shares
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Common shares
10,000
a. Complete the following table given earnings
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Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors
in the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here.
Lenow
Hall
Debt @ 9%
$
160,000
Debt @ 9%
$
320,000
Common stock, $10 par
320,000
Common stock, $10 par
160,000
Total
$
480,000
Total
$
480,000
Common shares
32,000
Common shares
16,000
a. Complete the following table given earnings
before interest and taxes of $20,000, $43,200, and $61,000. Assume
the tax rate...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors
in the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here.
Lenow
Hall
Debt @ 8%
$
300,000
Debt @ 8%
$
600,000
Common stock, $10 par
600,000
Common stock, $10 par
300,000
Total
$
900,000
Total
$
900,000
Common shares
60,000
Common shares
30,000
a. Complete the following table given earnings
before interest and taxes of $34,000, $72,000, and $89,000. Assume
the tax rate...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors
in the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here.
Lenow
Hall
Debt @ 10%
$
110,000
Debt @ 10%
$
220,000
Common stock, $10 par
220,000
Common stock, $10 par
110,000
Total
$
330,000
Total
$
330,000
Common shares
22,000
Common shares
11,000
a. Complete the following table given earnings
before interest and taxes of $15,000, $33,000, and $56,000. Assume
the tax rate...
Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow Drug Stores and Hall Pharmaceuticals are competitors in
the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here.
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Hall
Debt @ 10%
$
140,000
Debt @ 10%
$
280,000
Common stock, $10 par
280,000
Common stock, $10 par
140,000
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420,000
Total
$
420,000
Common shares
28,000
Common shares
14,000
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Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug chain store business. The...
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the discount drug chain store business. The separate capital
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Hall
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$
70,000
Debt @ 9%
$
140,000
Common stock, $10 par
140,000
Common stock, $10 par
70,000
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$
210,000
Total
$
210,000
Common shares
14,000
Common shares
7,000
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Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug chain store business. The...
Lenow Drug Stores and Hall Pharmaceuticals are competitors in
the discount drug chain store business. The separate capital
structures for Lenow and Hall are presented here.
Lenow
Hall
Debt @ 8%
$
120,000
Debt @ 8%
$
240,000
Common stock, $10 par
240,000
Common stock, $10 par
120,000
Total
$
360,000
Total
$
360,000
Common shares
24,000
Common shares
12,000
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