Question

Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before interest and taxes of $180,000. The separate capital structures for Sterling and Royal are shown here: Debt @ 12% Sterling Royal $ 900,000 Debt @ 12% $ 300,000 600,000 1,200,000 Common stock, $5 par Common stock, $5 par $ 1,500,000 $ 1,500,000 Total Total 120,000 240,000 Common shares Common shares a. Compute earnings per share for both firms. Assume a 20 percent tax rate. Note: Round your answers to 2 decimal places. Earnings per Share Sterling Royal 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 21 for each company, what would its stock price be? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. 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 20 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 Royal

          Sterling Optical and Royal Optical both make glass frames and each is able to
generate earnings before interest and taxes of $180,000. The separate capital
structures for Sterling and Royal are shown here:
Debt @ 12%
Sterling
Royal
$ 900,000
Debt @ 12%
$ 300,000
600,000
1,200,000
Common stock, $5 par
Common stock, $5 par
$ 1,500,000
$ 1,500,000
Total
Total
120,000
240,000
Common shares
Common shares
a. Compute earnings per share for both firms. Assume a 20 percent tax rate.
Note: Round your answers to 2 decimal places.
Earnings per
Share
Sterling
Royal
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 21 for each company, what
would its stock price be?
Note: Do not round intermediate calculations. Round your answer to 2
decimal places.
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 20 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
Royal

Sterling Optical and Royal Optical both make glass frames and each is able to
generate earnings before interest and taxes of 180,000. The separate capital
structures for Sterling and Royal are shown here:
Debt @ 12%
Sterling
Royal 900,000
Debt @ 12%
300,000
600,000
1,200,000
Common stock,5 par
Common stock, 5 par 1,500,000
1,500,000
Total
Total
120,000
240,000
Common shares
Common shares
a. Compute earnings per share for both firms. Assume a 20 percent tax rate.
Note: Round your answers to 2 decimal places.
Earnings per
Share
Sterling
Royal
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 21 for each company, what
would its stock price be?
Note: Do not round intermediate calculations. Round your answer to 2
decimal places.
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 20 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
Royal

Added by Alexandra P.

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