Sterling Optical and Royal Optical both make glass frames and each is able to ge

Question

Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $140,800. The separate capital structures for Sterling and Royal are shown next:

Compute earnings per share for both firms. Assume a 25 percent tax rate. (Round your answers to 2 decimal places.)

In part a, you should have gotten the same answer for both companies’ earnings per share. Assuming a P/E ratio of 24 for each company, what would its stock price be? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Now as part of your analysis, assume the P/E ratio would be 18 for the riskier company in terms of heavy debt utilization in the capital structure and 21 for the less risky company. What would the stock prices for the two firms be under these assumptions? (Note: Although interest rates also would likely be different based on risk, we will hold them constant for ease of analysis.) (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Sterling Royal

Explanation / Answer

Particulars

Sterling

Royal

EBIT

$140800

$140800

Interest

$84480

$28160

EBT

$56320

$112640

Taxes

$14080

$28160

Net Income

$42240

$84480

No. of Shares

102400

204800

Earning Per Share

$.41

$.41

Stock Price = P/E Ratio * Earning Per Share ($.41*24)

$9.84

Sterling

Royal

Earning Per Share

$.41

$.41

P/E Ratio

18

21

Stock Price

$7.38

$8.61

Particulars

Sterling

Royal

EBIT

$140800

$140800

Interest

$84480

$28160

EBT

$56320

$112640

Taxes

$14080

$28160

Net Income

$42240

$84480

No. of Shares

102400

204800

Earning Per Share

$.41

$.41

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