Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount d

Question

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.

a. Complete the following table given earnings before interest and taxes of $18,000, $42,000, and $59,000. Assume the tax rate is 30 percent. (Negative amounts should be indicated by parentheses or a minus sign. Round your answers to 2 decimal places.)
EBIT Total Assets EBIT/TA Lenow EPS Hall EPS the EPS of the two firms?

$18,000 $420,000 ______ % ________ _______ ______________

$42,000 $420,000 10.00 % ________ ________ _______________

$59,000 $420,000 ______ % _________ _________ _______________

b-1. 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 12 percent and all other factors remained equal, what would be the break-even level for EBIT?
  

Break-even level

Lenow Hall Debt @ 10% $ 140,000 Debt @ 10% $ 280,000 Common stock, $10 par 280,000 Common stock, $10 par 140,000 Total $ 420,000 Total $ 420,000 Common shares 28,000 Common shares 14,000

Explanation / Answer

a.

b-1. EBIT/TA =10%(cost of debt) , then the firm' will have equal EPS

b-2   Cost of debt =  10%

b-3. EPS is unaffected by financial leverage when the pre-tax return on assets (EBIT/TA) equals the cost of debt

c. EBIT/TA =cost of debt

EBIT/$420,000 =0.12

EBIT = 50400

Lenow’s Drug Stores Hall’s Pharmaceuticals 1. earnings before interest and tax 18000 18000 less: interest 14000 28000 Earning before tax 4000 -10000 less: Tax@30% 1200 3000 Earning after tax 2800 -7000 EPS [Earning after tax /Common shares ] 0.1 -0.5 Lenow EPS > Hall EPS 2. Earnings before interest and tax $42,000 $42,000 less: interest 14000 28000 Earning before tax 28000 14000 less: Tax@30% 8400 4200 Earning after tax 19600 9800 EPS [Earning after tax /Common shares] 0.7 0.7 Lenow EPS = Hall EPS 3. Earnings before interest and tax 59,000 59,000 less: interest 14000 28000 Earning before tax 45000 31000 less: Tax@30% 13500 9300 Earning after tax 31500 21700 EPS [Earning after tax /Common shares] 1.13 1.55 Lenow EPS < Hall EPS

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