Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $97,600.
The separate capital structures for Sterling and Royal are shown below:
Sterling Royal
Debt @ 8% $ 732,000 Debt @ 8% $ 244,000
Common stock, $5 par 488,000 Common stock, $5 par 976,000
Total $ 1,220,000 Total $ 1,220,000
Common shares 97,600 Common shares 195,200
(a) Compute earnings per share for both firms. Assume a 25 percent tax rate. (Round your answers to 2 decimal places. Omit the "tiny_mce_markerquot; sign in your response.)
Earnings per share
Sterling $
Royal $
(b) In part a, you should have gotten the same answer for both companies' earnings per share. Assuming a P/E ratio of 21 for each company, what would its stock price be? (Use rounded Earnings per share. Round your answer to 2 decimal places. Omit the "tiny_mce_markerquot; sign in your response.)
Stock price $
(c) Now as part of your analysis, assume the P/E ratio would be 15 for the riskier company in terms of heavy debt utilization in the capital structure and 24 for the less risky company. What would the stock prices for the two firms be under these assumptions? (Note: Although interest rates also would likely be different based on risk, we will hold them constant for ease of analysis.) (Use rounded Earnings per share. Round your answers to 2 decimal places. Omit the "tiny_mce_markerquot; sign in your response.)
Stock price
Sterling $
Royal $