Reference no: EM132838213
Question - Leverage and stockholder wealth - Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $168,000. The separate capital structures for Sterling and Royal are shown here:
Sterling Royal
Debt @ 12% $840,000 Debt @ 12% $280,000
Common stock, $5 par 560,000 Common stock, $5 par 1,120,000
Total $1,400,000 Total $1,400,000
Common shares 112,000 Common shares 224,000
Required -
a. Compute earnings per share for both firms. Assume a 25 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 21 for the less risky company. What would the stock prices for the two firms be under these assumptions?
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