18. Sterling Optical and Royal Optical both make glass frames and each is able t
ID: 2686132 • Letter: 1
Question
18. Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $120,000. The separate capital structures for Sterling and Royal are shown below: Sterling Royal Debt @ 1 2% ................................ $ 600,000 Debt @ 1 2% .......................... $ 200,000 Common stock, $5 par ................ 400,000 Common stock, $5 par .......... 800,000 Total ......................................... $1 ,000,000 Total ................................... $1 ,000,000 Common shares .......................... 80,000 Common shares .................... 1 60,000 a. Compute earnings per share for both firms. Assume a 25 percent tax rate. b. In part a, you should have gotten the same answer for both companiesExplanation / Answer
sterling
royal
EBIT
120 000
120 000
LESS INTEREST
72000
24000
EBIT
48 000
96000
LESS TAXES
12 000
24 000
EAT
36000
72000
SHREA
80 000
160 000
EPS
0.45
0.45
STOCK PRICE =P/E X EPS =20 X 0.45= $ 9
STERLING =16 X0.45= $ 7.20
ROYAL =25 X0.45= $ 11.25
ULTIMATE OBJECTIVE SHOULD BE TOMAXIMIZE THE STOCK PRICE .WHILE MANAGEMENT WOULD BE INDIFEENT BETWEEN TWO PLANS BASED ON EARNING PER SHARE , ROYAL OPTICAL WITH THE LESS RISSKY PLAN, HAS AHIGHER STOCK PRICE
sterling
royal
EBIT
120 000
120 000
LESS INTEREST
72000
24000
EBIT
48 000
96000
LESS TAXES
12 000
24 000
EAT
36000
72000
SHREA
80 000
160 000
EPS
0.45
0.45
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