Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...

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Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...

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.

Lenow			Hall
Debt @ 8%	$	270,000	Debt @ 8%	$	540,000
Common stock, $10 par		540,000	Common stock, $10 par		270,000
Total	$	810,000	Total	$	810,000
Common shares		54,000	Common shares		27,000

a. Complete the following table given earnings before interest and taxes of $31,000, $64,800, and $81,000. 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

31,000 $810,000

64,800 $810,000

81,000 $810,000
b-1. What is the EBIT/TA rate when the firm's have equal EPS?

b-2. What is the cost of debt?

b-3. 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?

business finance

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Answer 1

Answer #1

Please provide rating..

Answer a.
	i	ii	iii=i/ii
	EBIT	Total asset	EBIT/TA	Lenow EPS	Hall EPS
	31000	810000	3.83%	0.16	-0.41
	64800	810000	8.00%	0.72	0.72
	81000	810000	10.00%	0.99	1.26

	Computation of EPS

		Lenow				Hall
i	EBIT	31000	64800	81000		31000	64800	81000
ii	interest	21600	21600	21600		43200	43200	43200
iii=i-ii	EBT	9400	43200	59400		-12200	21600	37800
iv=iii*.7	PAT=EBT*(1-0.1)	8460	38880	53460		-10980	19440	34020
v	Share out standing	54000	54000	54000		27000	27000	27000
vi=iv/v	EPS	0.16	0.72	0.99		(0.41)	0.72	1.26


Answer b.-1
	at 8% EBIT/TA both the firm has equal EPS

Answer b.-2
	Cost of debt =8%

Answer b.-3

	relationship
	Pretax return is lower than cost of debt therefore Hall EPS is lower compared to Lenow
	Pretax return is equal to the cost of debt therefore both EPS are equal
	pretax return is higher than cost of debt therefore Lenow EPS is lower than Hall EPS


Answer c
	Break even level if debt cost incresed to 10%
	At break even (with 10% cost of debt) we should have EBIT/TA = 10%

	EBIT = 12%* TA
	EBIT =	10%*810000
	EBIT =	81000

	Breakeven EBIT =	81000

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Answer 2

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