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 $106,000. The separate capital structures for Sterling and Royal are shown here:

a. Compute earnings per share for both firms. Assume a 30 percent tax rate. (Round your answers to 2 decimal places.)
Earnings per Share

Sterling _____

Royal ______

b. In part a, you should have gotten the same answer for both companies’ earnings per share. Assuming a P/E ratio of 20 for each company, what would its stock price be? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
  

Stock Price_______

c. Now as part of your analysis, assume the P/E ratio would be 14 for the riskier company in terms of heavy debt utilization in the capital structure and 22 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 answers to 2 decimal places.)
Stock Price

Sterling ______

Royal ______

Sterling Royal Debt @ 10% $ 636,000 Debt @ 10% $ 212,000 Common stock, $5 par 424,000 Common stock, $5 par 848,000 Total $ 1,060,000 Total $ 1,060,000 Common shares 84,800 Common shares 169,600

Explanation / Answer

Sterling Royale Earnings before Interest and Tax 106000 Earnings before Interest and Tax 106000 Less Interest 63600 Less Interest 21200 EBT 42400 EBT 84800 Tax @ 30% 12720 Tax @ 30% 25440 Net Profit 29680 Net Profit 59360 No of Shares 84800 No of Shares 169600 EPS 0.35 EPS 0.35 (Net Profit / No of SHARES) (Net Profit / No of SHARES) Assuming PE Ratio of 20 price of the company, Price 7 Assuming PE Ratio of 20 price of the company, Price 7 (PE Ratio * EPS) Assuming PE Ratio of 14 as high debt 4.9 Assuming PE Ratio of 22as low debt 7.7 (PE Ratio * EPS) (PE Ratio * EPS)

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