Please provide rating...
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 return 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 |
Lenow's Drug Stores and Hall's Pharmaceuticals are competitors in the discount drug chain store business. The...
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