![Problem 5-16 Earnings per share and financial leverage [LO5-4] Lenows Drug Stores and Halls Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented here Lenow Hall Debt @ 10% Common stock, $10 par Total Common shares $ 200,000 100,000 $300,000 10,000 $100.000 Debt@ 10% 200,000 S300,000 Common stock, S10 par Total 20,000 Common shares a. Complete the following table given earnings before interest and taxes of $20,000, $30,000, and $120,000. Assume the tax rate is 30 percent. (Round your answers to 2 decimal places.) What is the relationship between the EPS of the two firms? Total assets EBIT/TA % EBIT $20,000300,000 $ 30,000 300,000 $120,000300,000 Lenow EPS Hall EPS](http://img.homeworklib.com/questions/d878bfd0-4966-11ea-898e-83cdc4fe13aa.png?x-oss-process=image/resize,w_560)
Homework Answers
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| Answer a. | |||||||||||||||
| i | ii | iii=i/ii | |||||||||||||
| EBIT | Total asset | EBIT/TA | Lenow EPS | Hall EPS | relationship | ||||||||||
| 20000 | 300000 | 6.67% | 0.35 | 0 | Pretax return is lower than cost of debt therefore Hall EPS is lower compared to Lenow | ||||||||||
| 30000 | 300000 | 10.00% | 0.7 | 0.7 | Pretax retun is equal to the cost of debt therefore both EPS are equal | ||||||||||
| 120000 | 300000 | 40.00% | 3.85 | 7 | pretax return is higher than cost of debt therefore Lenow EPS is lower than Hall EPS | ||||||||||
| Computation of EPS | |||||||||||||||
| Lenow | Hall | ||||||||||||||
| i | EBIT | 20000 | 30000 | 120000 | 20000 | 30000 | 120000 | ||||||||
| ii | interest | 10000 | 10000 | 10000 | 20000 | 20000 | 20000 | ||||||||
| iii=i-ii | EBT | 10000 | 20000 | 110000 | 0 | 10000 | 100000 | ||||||||
| iv=iii*.7 | PAT=EBT*(1-0.3) | 7000 | 14000 | 77000 | 0 | 7000 | 70000 | ||||||||
| v | Share out standing | 20000 | 20000 | 20000 | 10000 | 10000 | 10000 | ||||||||
| vi=iv/v | EPS | 0.35 | 0.7 | 3.85 | 0 | 0.7 | 7 | ||||||||
| Answer b.-1 | |||||||||||||||
| at 10% EBIT/TA both the firm has equal EPS | |||||||||||||||
| Answer b.-2 | |||||||||||||||
| Cost of debt =10% | |||||||||||||||
| Answer b.-3 | |||||||||||||||
| EPS is unaffected by financial leverage when pre-tax return on asset (EBIT/TA) is equal to the cost of debt. | |||||||||||||||
| Answer c | |||||||||||||||
| Break even level if debt cost increased to 12% | |||||||||||||||
| At break even (with 12% cost of debt) we should have EBIT/TA = 12% | |||||||||||||||
| EBIT = 12%* TA | |||||||||||||||
| EBIT = | 12%*300000 | ||||||||||||||
| EBIT = | 36000 | ||||||||||||||
| Break even EBIT = | 36000 | ||||||||||||||
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IVE HOMEWORK Saved Help Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug chain store business. The separate capita structures for Lenow and Hall are presented here. Hall Debt @ 10 Common stock, $10 par Total Common shares $100,000 Debt @ 10% 200,000 Common stock, $10 par 300,000 Total $200,000 100,000 300,000 10,000 20,000 Common shares a. Complete the following table given earnings before interest and taxes of $20,000, $30,000, and $120,000. Assume the tax rate is...
Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The...
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Lenow Drug Stores and Hall Pharmaceuticals are competitors in the discount drug chain store business. The separate cap...
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 Debt @ 10% Common stock, $10 par Total Common shares Hall $140,000 Debt @ 10% 280,000 Common stock, $10 par $420,000 Total 28,000 Common shares $ 280,000 140,000 $420,000 14,000 a. Complete the following table given earnings before interest and taxes of $18,000, $42,000, and $59,000. Assume the tax rate is 30 percent....
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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% $ 300,000 Debt @ 8% $ 600,000 Common stock, $10 par 600,000 Common stock, $10 par 300,000 Total $ 900,000 Total $ 900,000 Common shares 60,000 Common shares 30,000 a. Complete the following table given earnings before interest and taxes of $34,000, $72,000, and $89,000. Assume the tax rate...
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