PLEASE SHOW COMPUTATIONS FOR HOW YOU ARRIVED AT EACH ANSWER...THANK YOU Lenow’s
ID: 2729732 • Letter: P
Question
PLEASE SHOW COMPUTATIONS FOR HOW YOU ARRIVED AT EACH ANSWER...THANK YOU
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 next.
a. Complete the following table given earnings before interest and taxes of $19,000, $36,000, and $60,000. Assume the tax rate is 10 percent. (Leave no cells blank - be certain to enter "0" wherever required. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
What is the relationship between the EPS
of the two firms?
What is the EBIT/TA rate when the firm's have equal EPS? EBIT/TA rate ______ %
b-2. What is the cost of debt? Cost of debt ______ %
b-3. State the relationship between earnings per share and the level of EBIT. EPS is unaffected by financial leverage when the pre-tax return on assets (EBIT/TA) the cost of debt.
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? Break-even level $_________
Comment
Lenow Hall Debt @ 8% $ 150,000 Debt @ 8% $ 300,000 Common stock, $10 par 300,000 Common stock, $10 par 150,000 Total $ 450,000 Total $ 450,000 Common shares 30,000 Common shares 15,000Explanation / Answer
EBIT (in $)
TA (in $)
EBIT/TA (in %)
Lenow EPS (in $)
Hall EPS (in $)
Relationship bw EPS of two firms
19,000
450,000
4.22
0.21
-0.33
Lenow's EPS > Hall's EPS
36,000
450,000
8.00
0.72
0.72
Lenow's EPS = Hall's EPS
60,000
450,000
13.33
1.44
2.16
Lenow's EPS < Hall's EPS
EPS = EAT/Common Stock
EAT = EBIT – Interest – Tax
EPS calculation
Particulars
Lenow EPS
Hall EPS
EBTI
19,000
36,000
60,000
19,000
36,000
60,000
Less: Interest @8% on Debt
-12,000
-12,000
-12,000
-24,000
-24,000
-24,000
EBT
7,000
24,000
48,000
-5,000
12,000
36,000
Less: Tax @10%
-700
-2,400
-4,800
0
-1,200
-3,600
EAT A
6,300
21,600
43,200
-5,000
10,800
32,400
Common Stock B
30,000
30,000
30,000
15,000
15,000
15,000
EPS (A/B)
0.21
0.72
1.44
-0.33
0.72
2.16
B-1. The EBIT/TA rate when the firms have equal EPS is 8%
B-2. Cost of Debt = 8-10% = 7.2% (Cost of debt is to be taken after tax rate)
B-3. The EPS and EBIT are directly proportional as the EPS is increasing with increase in level of EBIT.
EBIT (in $)
TA (in $)
EBIT/TA (in %)
Lenow EPS (in $)
Hall EPS (in $)
Relationship bw EPS of two firms
19,000
450,000
4.22
0.21
-0.33
Lenow's EPS > Hall's EPS
36,000
450,000
8.00
0.72
0.72
Lenow's EPS = Hall's EPS
60,000
450,000
13.33
1.44
2.16
Lenow's EPS < Hall's EPS
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