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Compute earnings per share for both firms

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Question - Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $126,000. The separate capital structures for Sterling and Royal are shown here:

Sterling

Debt @ 10% $756,000

Common stock, $5 par 504,000

Total $1,260,000

Common shares 100,800

Royal

Debt @ 10% $252,000

Common stock, $5 par 1,008,000

Total $1,260,000

Common shares 201,600

Required -

a. Compute earnings per share for both firms. Assume a 20 percent tax rate.

b. In part a, you should have gotten the same answer for both companies' earnings per share. Assuming a P/E ratio of 23 for each company, what would its stock price be?

c. Now as part of your analysis, assume the P/E ratio would be 17 for the riskier company in terms of heavy debt utilization in the capital structure and 20 for the less risky company. What would the stock prices for the two firms be under these assumptions?

Reference no: EM132792093

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