Lenow’s Drug Stores and Hall’s Pharmaceuticals
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 next.
| 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 is 10 percent. (Leave no cells blank – be certain to enter “0” wherever required. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.) |
| EBIT | Total assets | EBIT/TA | Lenow EPS | Hall EPS | What is the relationship between the EPS of the two firms? |
| $ 34,000 | $900,000 | % | $ | $ | (Click to select)Lenow’s EPS > Hall’s EPSLenow’s EPS = Hall’s EPSLenow’s EPS < Hall’s EPS |
| $ 72,000 | $900,000 | % | $ | $ | (Click to select)Lenow’s EPS > Hall’s EPSLenow’s EPS = Hall’s EPSLenow’s EPS < Hall’s EPS |
| $89,000 | $900,000 | % | $ | $ | (Click to select)Lenow’s EPS > Hall’s EPSLenow’s EPS = Hall’s EPSLenow’s EPS < Hall’s EPS |
| 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) (Click to select)equalsexceedsis less than 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 | $ |
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