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.

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		15,000

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.)

What is the relationship between the EPS of the two firms? EBIT/TA % Lenow EPS Hall EPS $ $ $ EBIT 19,000 36,000 60,000 Total Assets $ 450,000 $ 450,000 $ 450,000

Answer 1

rate positively ...

	i	ii
	EBIT	Total asset	EBIT/TA	Lenow EPS	Hall EPS	relationship
	19000	450000	4.22%	0.21	(0.30)	Pretax return is lower than cost of debt therefore Hall EPS is lower compared to Lenow
	36000	450000	8.00%	0.72	0.72	Pretax retun is equal to the cost of debt therefore both EPS are equal
	60000	450000	13.33%	1.44	2.16	pretax return is higher than cost of debt therefore Lenow EPS is lower than Hall EPS
	Computation of EPS
		Lenow		Hall
i	EBIT	19000	36000	60000		19000	36000	60000
ii	interest	12000	12000	12000		24000	24000	24000
iii=i-ii	EBT	7000	24000	48000		-5000	12000	36000
iv=iii*.9	PAT=EBT*(1-0.1)	6300	21600	43200		-4500	10800	32400
v	Share out standing	30000	30000	30000		15000	15000	15000
vi=iv/v	EPS	0.21	0.72	1.44		(0.30)	0.72	2.16