Question
In: Finance
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 | |||
Complete the following table given earnings before interest and
taxes of $16,000, $28,800, and $57,000. Assume the tax rate is 10
percent. (Negative amounts should be indicated by
parentheses or a minus sign. Round your answers to
2 decimal places.)
| What is the relationship | ||||||
| EBIT | Total Assets | EBIT/TA | % | Lenow EPS | Hall EPS | of the two firms |
| $16,000 | $360,000 | |||||
| $28,800 | $360,000 | |||||
| $57,000 | $360,000 |
b. What is the EBIT/TA rate when the firm's have equal EPS?
b1. What is the cost of debt?
b2. State the relationship between earnings per share and the level of EBIT.
c. If the cost of debt went up to 10 percent and all other
factors remained equal, what would be the break-even level for
EBIT?
Solutions
Expert Solution
1.
| Lenow | Hull | |
| EBIT | 16000 | 16000 |
| Less:Interest | =120000*8% | =240000*8% |
| EBT | =16000-9600 | =16000-19200 |
| Less: Taxes@10% | =6400*0.9 | 0 |
| EAT | =6400-5760 | =-3200-0 |
| Shares | 24000 | 12000 |
| EPS | =640/24000 | =-3200/12000 |
| EBIT/TA | =16000/360000 | =16000/360000 |
| EBIT | 28800 | 28800 |
| Less:Interest | =120000*10% | =240000*10% |
| EBT | =28800-9600 | =28800-19200 |
| Less: Taxes@10% | =19200*0.9 | =9600*0.9 |
| EAT | =19200-17280 | =9600-8640 |
| Shares | 24000 | 12000 |
| EBIT/TA | =28800/360000 | =28800/360000 |
| EPS | =1920/24000 | =960/12000 |
| EBIT | 57000 | 57000 |
| Less:Interest | =120000*8% | =240000*8% |
| EBT | =57000-9600 | =57000-19200 |
| Less: Taxes@10% | =47400*0.9 | =37800*0.9 |
| EAT | =47400-42660 | =37800-34020 |
| Shares | 24000 | 12000 |
| EPS | =4740/24000 | =3780/12000 |
| EBIT/TA | =57000/360000 | =57000/360000 |
| Lenow | Hull | |
| EBIT | 16000 | 16000 |
| Less:Interest | 9600 | 19200 |
| EBT | 6400 | -3200 |
| Less: Taxes@10% | 5760 | 0 |
| EAT | 640 | -3200 |
| Shares | 24000 | 12000 |
| EPS | 0.02666667 | -0.26666667 |
| EBIT/TA | 0.04444444 | 0.044444444 |
| EBIT | 28800 | 28800 |
| Less:Interest | 12000 | 24000 |
| EBT | 19200 | 9600 |
| Less: Taxes@10% | 17280 | 8640 |
| EAT | 1920 | 960 |
| Shares | 24000 | 12000 |
| EBIT/TA | 0.08 | 0.08 |
| EPS | 0.08 | 0.08 |
| EBIT | 57000 | 57000 |
| Less:Interest | 9600 | 19200 |
| EBT | 47400 | 37800 |
| Less: Taxes@10% | 42660 | 34020 |
| EAT | 4740 | 3780 |
| Shares | 24000 | 12000 |
| EPS | 0.1975 | 0.315 |
| EBIT/TA | 0.15833333 | 0.158333333 |
B1))
| Lenow | Hull | |
| Cost of Debt (Pre Tax) | =8% | =8% |
| Cost of Debt (After Tax) | =8%*0.9 | =8%*0.9 |
| Lenow | Hull | |
| Cost of Debt (Pre Tax) | 8.000% | 8.000% |
| Cost of Debt (After Tax) | 7.200% | 7.200% |
B2))As EBIT Increates EPS increases for both firms, but more for Hull as it has less number of shares, Outstanding.
jeff jeffy answered 1 year agoRelated Solutions
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
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