"5-14. (Continued)Q(P - VC) b. DOL =Q(P-- VC) FC Q = 40,000 Total revenue $160,000 P = = = $4 Units sold 40,000 Total variable costs $80,000 VC = = = $2 Units sold 40,000 FC = $50,000 40,000 ($4 - $2) $80,000 DOL = = 40,000($4-- $2) $50,000 $80,000- $50,000 $80,000 = = $2.67 $30,000 15. Leno’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chainstore business. The separate capital structures for Leno and Hall are presented below.Leno HallDebt @ 10% ......................... $100,000 Debt @ 10% .......................... $200,000Common stock, $10 par ....... 200,000 Common stock, $10 par ........ 100,000Total ..................................... $300,000 Total ...................................... $300,000Shares ................................... 20,000 Common shares ..................... 10,000 a. Compute earnings per share if earnings before interest and taxes are $20,000,$30,000, and $120,000 (assume a 30 percent tax rate). b. Explain the relationship between earnings per share and the level of EBIT. c. If the cost of debt went up to 12 percent and all other factors remained equal, whatwould be the break-even level for EBIT?S5-18 5-15. Solution:a. Leno Drug Stores and Hall Pharmaceuticals Leno Hall EBIT $ 20,000 $ 20,000 Less: Interest10,00020,000 EBT 10,000 0 Less: Taxes @ 30% 3,000 0 EAT 7,000 0 Shares 20,000 10,000 EPS $ .35 0 EBIT $ 30,000 $ 30,000 Less: Interest10,00020,000 EBT 20,000 10,000 Less: Taxes @ 30% 6,000 3,000 EAT 14,000 7,000 Shares 20,000 10,000 EPS $.70 $.70 EBIT $120,000 $120,000 Less: Interest 10,000 20,000 EBT 110,000 100,000 Less: Taxes @ 30% 33,000 30,000 EAT 77,000 70,000 Shares 20,000 10,000 EPS $ 3.85 $7.00S5-19 5-15. (Continued)b. Before-tax return on assets = 6.67%, 10% and 40% at therespective levels of EBIT. When the before-tax return onassets (EBIT/Total Assets) is less than the cost of debt(10%), Leno does better with less debt than Hall. Whenbefore-tax return on assets is equal to the cost of debt, bothfirms have equal EPS. This would be where the method offinancing has a neutral effect on EPS. As return on assetsbecomes greater than the interest rate, financial leveragebecomes more favorable for Hall.c. 12% × $300,000 = $36,000 break-even level for EBIT.16. In Problem 15, compute the stock price for Hall Pharmaceuticals if it sells at 13 timesearnings per share and EBIT is $80,000.5-16. Solution:Hall Pharmaceuticals (Continued)EBIT $80,000Less: Interest 20,000EBT $60,000Less: Taxes @ 30% 18,000EAT $42,000Shares 10,000EPS $4.20P/E 13xStock Price $ 54.60S5-20 17. Pulp Paper Company and Holt Paper Company are each able to generate earnings beforeinterest and taxes of $150,000.The separate capital structures for Pulp and Holt are shown below:Pulp HoltDebt @ 10% ........................$ 800,000 Debt @ 10% ....................$ 400,000Common stock, $5 par ........700,000 Common stock, $5, par ...1,100,000Total ....................................$1,500,000 Total ................................$1,500,000Common shares ...................140,000 Common shares ...............220,000 a. Compute earnings per share for both firms. Assume a 40 percent tax rate. b. In part a, you should have the same answer for both companies’ earnings per share.Assuming a P/E ratio of 20 for each company, what would each company’s stockprice be? c. Now as part of your analysis, assume the P/E ratio would be 15 for the riskiercompany in terms of heavy debt utilization in the capital structure and 26 for the lessrisky company. What would the stock prices for the two firms be under theseassumptions? (Note: Although interest rates also would likely be different based onrisk, we hold them constant for ease of analysis). d. Based on the evidence in part c, should management only be concerned about theimpact of financing plans on earnings per share or should stockholders’ wealthmaximization (stock price) be considered as well?5-17. Solution:Pulp Paper Company and Holt Paper Companya. Pulp Holt EBIT $150,000 $150,000 Less: Interest 80,000 40,000 EBT 70,000 110,000 Less: Taxes @ 40% 28,000 44,000 EAT 42,000 66,000 Shares 140,000 220,000 EPS $.30 $.30b. Stock price = P/E ×EPS20 × $.30 = $6.00S5-21 5-17. (Continued)c. Pulp Holt15 × $.30 = $4.50 26 × $.30 = $7.80d. Clearly, the ultimate objective should be to maximize thestock price. While management would be indifferent betweenthe two plans based on earnings per share, Holt Paper, withthe less risky plan, has a higher stock price.18. Firms in Japan often employ both high operating and financial leverage because of the useof modern technology and close borrower-lender relationships. Assume the SusakiCompany has a sales volume of 100,000 units at a price of $25 per unit; variable costs are$5 per unit and fixed costs are $1,500,000. Interest expense is $250,000. What is the degreeof combined leverage for this Japanese firm?5-18. Solution:Susaki CompanyQ(P - VC) DCL = Q(P- VC)-- FC I 100,000 ($25 - $5) = 100,000 ($25-- $5) $1,500,000- $250,000100,000 ($20) = 100,000 ($20) - $1,750,000 $2,000,000 $2,000,000 = = = 8x $2,000,000 - $1,750,000 250,000 S5-22 "