Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount d
ID: 2814201 • Letter: L
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 $19,000, $36,000, and $60,000. 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.)
EBIT Total Assets EBIT/TA Lenow EPS Hall EPS the EPS of the two firms?
$19,000 $450,000 ______ % ________ _______ ______________
$36,000 $450,000 _______% ________ ________ _______________
$60,000 $450,000 ______ % _________ _________ _______________
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 10 percent and all other factors remained equal, what would be the break-even level for EBIT?
Break-even level
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
A. EBIT/ TOTAL ASSETS LENOW EPS HALL EPS
= $19,000/4,50,000 0.21 (0.37)
=4.22%
B. $36,000/$4,50,000 0.72 0.72
=0.08
=8%
C. $60,000/$4,50,000 1.44 2.16
=0.13
=13%
EPS CALCULATIONS:
EBIT: $19,000
INTEREST : $12,000
EBT: $7,000
TAX $700
NET INCOME : $6,300
EPS = $6300/30,000
= 0.21
HALL EPS:
EBIT: $19,000
INTEREST : $24,000
EBT : ($5000)
TAXES : ($500)
NET INCOME: ($5,500)
EPS : (0.37)
LENOW GRUGS:
EBIT : $36,000
INTEREST : $12,000
EBT: $24,000
TAXES : $2400
NET INCOME: $21,600
EPS= $21,600/30,000
=0.72
HALL EPS:
EBIT = $36,000
INTEREST : $24,000
EBT: $12,000
TAXES : $1200
NET INCOME: $10800
EPS: 0.72
LENOW EPS:
EBIT : $60,000
INTEREST: $12,000
EBT = $48,000
TAX: $4800
NET INCOME: $43,200
EPS: 1.44
HALL EPS:
EBIT = $60,000
INTEREST : $24,000
EBT :$36,000
TAXES ; $3,600
NET INCOME: $32,400
EPS = 2.16
b 2: THE COST OF DEBT IS 8%.
b - 3: EPS is unaffected by financila leverage , when the cost of debt is equal to the pre tax return on assets (EBIT/TA). AS THE RETURN OF ASSETS > COST OF DEBT, taking debt in the capital structure becomes favourable.
C. THE BREAK EVEN LEVEL IS :
IF THE COST OF DEBT GOES UP BY 10%,SO BREAK EVEN LEVEL IS :
10% * SUM OF DEBT AND EQUITY
WHICH IS
10%* 4,50,000
= $45,000 IS THE BREAK EVEN LEVEL
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