Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $146,000. The separate capital structures for Sterling and Royal are shown here: Sterling Debt @ 10% Common stock, $5 par Total Common shares Sterling Royal $ 876,000 584,000 $ 1,460,000 116,800 a. Compute earnings per share for both firms. Assume a 25 percent tax rate. Note: Round your answers to 2 decimal places. Stock price Earnings per Share Sterling Royal Royal Debt @ 10% Common stock, $5 par Total Common shares b. In part a, you should have gotten the same answer for both companies' earnings per share. Assuming a price- earnings (P/E) ratio of 19 for each company, what would its stock price be? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. $ 292,000 1,168,000 $ 1,460,000 233,600 c. Now as part of your analysis, assume the P/E ratio would be 13 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.) Note: Do not round intermediate calculations. Round your answers to 2 decimal places. Stock Price
Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $146,000. The separate capital structures for Sterling and Royal are shown here: Sterling Debt @ 10% Common stock, $5 par Total Common shares Sterling Royal $ 876,000 584,000 $ 1,460,000 116,800 a. Compute earnings per share for both firms. Assume a 25 percent tax rate. Note: Round your answers to 2 decimal places. Stock price Earnings per Share Sterling Royal Royal Debt @ 10% Common stock, $5 par Total Common shares b. In part a, you should have gotten the same answer for both companies' earnings per share. Assuming a price- earnings (P/E) ratio of 19 for each company, what would its stock price be? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. $ 292,000 1,168,000 $ 1,460,000 233,600 c. Now as part of your analysis, assume the P/E ratio would be 13 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.) Note: Do not round intermediate calculations. Round your answers to 2 decimal places. Stock Price
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Concept explainers
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
100%
Transcribed Image Text:Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and
taxes of $146,000. The separate capital structures for Sterling and Royal are shown here:
Sterling
Debt @ 10%
Common stock, $5 par
Total
Common shares
Sterling
Royal
Stock price
a. Compute earnings per share for both firms. Assume a 25 percent tax rate.
Note: Round your answers to 2 decimal places.
Royal
Debt @ 10%
Common stock, $5 par
Total
116,800 Common shares
$ 1,460,000
Earnings per
Share
Sterling
Royal
$ 876,000
584,000
b. In part a, you should have gotten the same answer for both companies' earnings per share. Assuming a price-
earnings (P/E) ratio of 19 for each company, what would its stock price be?
Note: Do not round intermediate calculations. Round your answer to 2 decimal places.
$ 292,000
1,168,000
$ 1,460,000
233,600
Stock Price
c. Now as part of your analysis, assume the P/E ratio would be 13 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.)
Note: Do not round intermediate calculations. Round your answers to 2 decimal places.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 9 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education