Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug

Question

Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented here.

Complete the following table given earnings before interest and taxes of $16,000, $28,800, and $57,000. Assume the tax rate is 10 percent. (Negative amounts should be indicated by parentheses or a minus sign. Round your answers to 2 decimal places.)
  

b. What is the EBIT/TA rate when the firm's have equal EPS?

b1. What is the cost of debt?

b2. State the relationship between earnings per share and the level of EBIT.

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?
  

Lenow Hall Debt @ 8% $ 120,000 Debt @ 8% $ 240,000 Common stock, $10 par 240,000 Common stock, $10 par 120,000 Total $ 360,000 Total $ 360,000 Common shares 24,000 Common shares 12,000

Explanation / Answer

1.

B1))

B2))As EBIT Increates EPS increases for both firms, but more for Hull as it has less number of shares, Outstanding.

Lenow Hull EBIT 16000 16000 Less:Interest =120000*8% =240000*8% EBT =16000-9600 =16000-19200 Less: Taxes@10% =6400*0.9 0 EAT =6400-5760 =-3200-0 Shares 24000 12000 EPS =640/24000 =-3200/12000 EBIT/TA =16000/360000 =16000/360000 EBIT 28800 28800 Less:Interest =120000*10% =240000*10% EBT =28800-9600 =28800-19200 Less: Taxes@10% =19200*0.9 =9600*0.9 EAT =19200-17280 =9600-8640 Shares 24000 12000 EBIT/TA =28800/360000 =28800/360000 EPS =1920/24000 =960/12000 EBIT 57000 57000 Less:Interest =120000*8% =240000*8% EBT =57000-9600 =57000-19200 Less: Taxes@10% =47400*0.9 =37800*0.9 EAT =47400-42660 =37800-34020 Shares 24000 12000 EPS =4740/24000 =3780/12000 EBIT/TA =57000/360000 =57000/360000

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