Purchase Solution

# I need help finding the answers to some problems, the class in Operating and Financial leverage.

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Can you help me with this problem:

Cain Auto Supplies and Able Auto Parts are competitors in the aftermarket for auto supplies. The seperate capital structures for Cain and Able are presented below:

Cain
Debt @10%...............\$50,000
Common Stock, \$10 par.....100,000

Total................................\$150,000
Common Shares............... 10,000

ABLE
Debt @ 10%......................\$100,000
Common stock, \$10 par...... 50,000
Total.................................\$150,000
Common Shares............... 5,000

a) How do I compare earnings per share if earnings before interest and taxes are \$10,000, \$15,000, and \$50,000 (assume a 30 percent tax rate).

b) How do I explain the relationship between earnings per share and the lebel of EBIT?

c) How do i explain the following: If the cost of debt went up to 12 percent and all other factors remained equal, what would be the break-even level for EBIT?

I GREATLY appreciate your help, Thank you!!

##### Solution Preview

a) How do I compare earnings per share if earnings before interest and taxes are \$10,000, \$15,000, and \$50,000 (assume a 30 percent tax rate).
EPS =(EBIT - I) (1-t) / n
For Cain, Ic = 50,000*10% = 5,000
And for ABLE, Ia = 100,000*10% = 10,000

When EBIT= \$10,000 for both,
EPSc = (10,000 - 5000) (1-30%) / 10,000 = 0.35
EPSa = (10,000 - 10000) (1-30%) / 5,000 = 0
Then EPS of Cain > EPS of ABLE

When EBIT= \$15,000 for both, ...

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