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Capital Structure Policy

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15-1.

total liabilities

debt ratio =

.

total assets

Webbs total debt includes both its current liabilities of $750,000 and its long-term debt of

$750,000. Webbs total debt is therefore $1,500,000. Its total assets, which equal the total of

its debt and owners equity, equal $2,000,000. The firms debt ratio is therefore:

$1,500,000

debt ratio =

= 75%.

$2,000,000

Using its book values, then, Webb appears heavily debt-financed, funding 75% of its assets

with debt.

The debt ratio includes all of Webbs debt, and is a reflection of the firms financial structure.

If instead we were to focus only on its interest-bearing debt, then we would omit accounts

payable from the ratios numerator, giving us the interest-bearing debt ratio:

$1,000,000

interest-bearing debt ratio =

= 50%.

$2,000,000

(This is a measure of the firms capital structure.) Omitting Webbs $500,000 in A/P

decreases the relevant proportion of debt to assets from 75% to 50%.

B. If we were interested in Webbs debt-to-value ratio, we would need to find the ratio of the

market value of Webbs interest-bearing debt to the sum of the market values of both its

interest-bearing debt and equity:

debt-to-value ratio =

TMVdebt

,

(TMVdebt + TMVequity )

where the debt is the interest-bearing debt. (Note that equation 15-2 expresses the debt values

as book values, noting that they are approximating the market values. Debts relative illiquidity

makes it more difficult to find market values for a firms debt than for its equity.)

We are told that Webbs debts market value is the same as its book value. Since were using

only the interest-bearing debt, this means that TMVint-bearing debt = $1M. Thus, its debt-to-value

ratio is:

debt-to-value ratio =

$1,000,000

= 33.33%.

($1,000,000 + $2,000,000)

400

Titman/Keown/Martin

This is lower than its debt ratio, since the numerator of the debt-to-value ratio omits noninterest-bearing debt (smaller numerator) and the denominator includes the market value of the

firms equity (almost always larger than its book value of equity; larger denominator).

C. If I were a bank loan officer evaluating Webb for a new loan, I would consider Webbs ability

to repay my loanits ability to meet the required principal and interest payments. The most

relevant of the three debt-related ratios we have calculated is the third, the debt-to-value ratio.

The total assets in the denominator of the first two ratios doesnt measure Webbs ability to

tap the financial markets for funding. However, the value in the denominator of the third

suggests that Webbs equity is much more valuable in the market than it appears from the

balance sheet. This tells me that Webbs debt burden is not as high as it otherwise appears

2/3 of its firm value actually comes from equity. There is better capacity to repay additional

debt that is suggested by its simple book-value debt ratios.

15-2.

As we learned in Chapter 14, and as is summarized in Figure 14.1, we use market values to

determine a firms capital structure weights. The market value of Moes equity is simply the

number of common shares it has outstanding, times the price per share:

total MV of equity = (price/share) (# of shares)

= $80 (1,000,000)

= $80,000,000.

(Note that we ignore the book value per share, since we are only concerned with market values.

Also note that Moes total equity market value exceeds its book value, as is the usual case.)

To find Moes market value for debt, we follow the same principle, multiplying the price per bond

by the number of bonds. Since the bonds each sell for 110% of par, or ($1,000) (1.10) = $1,100,

we have:

total MV of debt = (price/bond) (# of bonds)

= $1,100 (100,000)

= $110,000,000,

which again exceeds the book value (since the bonds are selling at a premium). Now, we can see that:

weight of debt =

$110,000,000

= 57.89%,

($110,000,000 + $80,000,000)

15-3.

total liabilities

debt ratio =

.

total assets

Ojais balance sheet has $50,000,000 in total liabilities and $50,000,000 in total equity. Its total

assets, which equal the total of its debt and owners equity, equal $100,000,000. The firms

debt ratio is therefore:

$50,000,000

debt ratio =

= 50%.

$100,000,000

401

According to its balance sheet, Ojai finances half of its assets with debt.

If we restrict our attention solely to the firms interest-bearing debt, we use only the

$40,000,000 in short- and long-term debt in the numerator, finding:

$40,000,000

interest-bearing debt ratio =

= 40%.

$100,000,000

Omitting liability items such as accounts payable lowers this ratio relative to Ojais debt ratio.

B. If we use market values instead of book values, we note that Ojais debt is valued at $55,000,000,

which includes accounts payable (if we exclude accounts payable, debt market value is

$45,000,000), while its equity is valued at $100,000,000, so that its debt-to-value ratio is:

debt-to-value ratio =

=

TMVdebt

,

(TMVdebt + TMVequity )

$45,000,000

= 31%.

($45,000,000 + $100,000,000)

This ratio is lower than the debt ratio despite the debts 10% premium over book, because

the difference between the market and book values of the firms equity is even more dramatic.

While Ojais debt and equity have the same book values (so that the debt ratio is 50%), the

market value for the equity is twice as large as this BV. Debts 10% market-value premium

pales in comparison. Thus, in market value terms, Ojai finances only 31% of its assets with debt.

C. If I were trying to describe Ojais capital structure to a potential lender, I would use the market

value-based debt-to-value ratio. Book values do not reflect current market values (by definition).

Book values are essentially historical artifacts. Ojai is not issuing debt in some earlier, historic

periodit is issuing debt today in todays market environment. If we want to know how the

market responds to Ojais current situation, we need to look to the markets current values for

the firms securities. Market values give us the up-to-date market assessments that we need;

book values cannot.

Wouldnt a lender want to know how much money Ojai could raise if it had to sell equity to

1

repay a loan? Could it learn that from the balance sheet?

15-4.

total liabilities

debt ratio =

.

total assets

Curleys total debt includes both its current liabilities of $500,000 and its long-term debt of

$2,000,000. Curleys total debt is therefore $2,500,000. Its total assets, which equal the total of

its debt and owners equity, equal $4,000,000. The firms debt ratio is therefore:

$2,500,000

debt ratio =

= 62.5%.

$4,000,000

Of course, Ojais current equity market values reflect its current D/E ratio, not a ratio that might exist under some

future scenario with more debt. However, our estimate of future conditions is still better using current market values

than using book values.

402

Titman/Keown/Martin

Using only Curleys interest-bearing debt, we omit accounts payable from the ratios

numerator, giving us the interest-bearing debt ratio:

$2,400,000

interest-bearing debt ratio =

= 60%.

$4,000,000

This ratio, which uses only a subset of a firms total liabilities, is, as always, lower than the

debt ratio.

B. If the firm wishes to have a debt ratio of 50% after the expansion, then it clearly must increase

its relative equity funding. Let x equal the amount of new equity funding, so that the new debt

funding is ($2,000,000 x). Setting the debt ratio equal to 0.50, and solving for x, we have:

total liabilities

debt ratio =

total assets

$2,500,000 + [$2,000,000 x ]

0.50 =

[$4,000,000 + $2,000,000]

$4,500,000 x

0.50 =

$6,000,000

x = $1,500,000.

Thus, if Curley raises $1.5M in equity (for a total of $3M) and $500,000 in debt (for a total of

$3M), it will have a debt ratio of 50%.

15-5.

total liabilities

debt ratio =

total assets

$12,706,000 + $13,904,000

=

.

$44,324,000

$26,610,000

=

$44,324,000

= 46.5%.

If we consider only its interest-bearing debtthat is, if we ignore the $9,185,000 in accounts

payable, the $1,474,000 in other current liabilities, and the $2,521,000 in other long-term

liabilitieswe are left with debt totaling $13,430,000. Home Depots interest-bearing debt

ratio is thus:

$13,430,000

interest-bearing debt ratio =

= 30.3%,

$44,324,000

B. The debt ratio and interest-bearing debt ratio incorporate Home Depots book value of

common equity. What would the firms debt burden look like if we used their market values

instead? Assuming that the MV of the interest-bearing debt is the same as its BV, $13,430,000,

but recognizing that the MV of the equity is $44.90 billion, not $17.714 million, we have:

debt-to-value ratio =

403

TMVdebt

,

(TMVdebt +TMVequity )

debt-to-value ratio =

15-6.

$13,430,000

= 23%.

($13,430,000 + $44,900,000)

A. As we did in Problem 15-5, we find the relevant debt ratios for Lowes as:

total liabilities

debt ratio =

total assets

$7,751,000 + $6,246,000

=

.

$30,095,000

$13,997,000

=

$30,095,000

= 46.5%.

accounts payable, the $2,510,000 in other current liabilities, and the $670,000 in other longterm liabilitieswe are left with debt totaling $6,680,000. Lowes interest-bearing debt ratio

is thus:

$6,680,000

interest-bearing debt ratio =

= 22.2%,

$30,095,000

which, as with Home Depot, is a value only half as large as the debt ratio.

B. Considering the market values of Lowes interest-bearing debt and of its equity (where we

assume that the former is equal to the book value of $6,680,000), we find the debt-to-value

ratio as:

debt-to-value ratio =

$6,680,000

= 15.7%.

($6,680,000 + $35,860,000)

C. Lets compare the results for Home Depot (from Problem 15-5) and Lowes. Well present the

balance-sheet values for both companies as percentages of their book values and of their

market values (where the latter is the value from the denominator of their respective debt-tovalue ratios: their total market values of equity, plus their market [here, book] values of

interest-bearing debt). We find the following:

404

Titman/Keown/Martin

LOWE'S

BOOK VALUES:

accounts payable

short-term debt

other current liabilities

current liabilities

long-term debt

other long-term liabilities

long-term liabilities

TOTAL DEBT

EQUITY

TOTAL ASSETS = TOTAL D + OE

BV

%

13.75%

3.67%

8.34%

25.76%

18.53%

2.23%

20.75%

46.51%

53.49%

100.00%

$30,095,000

MARKET VALUES:

TMV OF EQUITY & INTEREST-BEARING DEBT

MV

%

0.01%

0.00%

0.01%

0.02%

0.02%

0.00%

0.02%

0.04%

0.04%

0.08%

HOME DEPOT

BV

%

20.72%

4.62%

3.33%

28.67%

25.68%

5.69%

31.37%

60.04%

39.96%

100.00%

$44,324,000

$35,866,680,000

MV

%

0.02%

0.00%

0.00%

0.03%

0.03%

0.01%

0.03%

0.06%

0.04%

0.10%

$44,913,430,000

In the market-value columns, we have shaded in gray the debt cells for the firm with the

higher values. For example, since Home Depots current liabilities are a larger percentage of

the firms market value than are Lowes current liabilities, we have shaded Home Depots

0.03% value. Since almost all of Home Depots debt values are larger in market-value terms

than Lowes, wed have to say that Home Depot employs more leverage. (Note that we are

considering market values, which are the relevant, current, measures of the firms

indebtedness.)

According to a report by Morningstar (New Credit Rating: Lowes, by Morningstars Credit

Committee, dated 1/5/10, available at

http://quicktake.morningstar.com/stocknet/san.aspx?id=321237; accessed 5/21/10),

Morningstar is initiating credit coverage of Lowes LOW with an issuer rating of A +, one

notch above more-levered peer Home Depot HD. The report praises Lowes very consistent,

low-leverage capital structure and its sensibly spread out debt repayment obligations,

noting that the companys debt-to-capital ratio has averaged 0.24 over the past five years.

Clearly, Morningstar considers relative debt to be an integral input to a firms debt ratings (of

course), and evaluates a firms debt burden against that of other firms in its industry.

15-7.

A. We can find Dharma Supplys net income as follows, as is illustrated in Section 15.2 of the

chapter:

EBIT

less interest expense

earnings before tax

less taxes at 35%

net income

$500,000

($300,000)

$200,000

($70,000)

$130,000

B. However, if Dharma had no debt, its situation would look like this:

EBIT

less interest expense

earnings before tax

less taxes at 35%

net income

$500,000

$0

$500,000

($175,000)

$325,000

405

Net income is much higher, since weve removed the interest expense deduction. However,

the total distribution that Dharma is able to make to its suppliers of fundsboth its

debtholders and its stockholdershas also changed:

C.

scenario #1:

equity dividends $130,000

interest payments $300,000

total distributions $430,000

scenario #2:

equity dividends $325,000

interest payments

$0

total distributions $325,000

When there is no debt, the total distributions made to equity- and debtholders (assuming that

all of the firms net income is paid to equity as dividends) falls by $105,000or 35% of the

total initial debt used of $300,000. This $105,000 is Dharmas interest tax savingsthe

amount by which Dharma reduces its payments to the government simply by using debt in its

capital structure. By not using debt in the second scenario, Dharma is passing up the

opportunity to have the government pay some of its funding costs (that is, it is passing up the

subsidy that the government offers for debt financing). By choosing an all-equity structure,

Dharma transfers some of its money to the government, through higher taxes, and away from

its own sources of funding.

15-8.

A. Swanks current EBIT is $100,000, and, after-taxes, it has $65,000 to distribute to its

shareholders. This $65,000 represents the total distributions that Swank makes to its funding

sources, since it has no debt.

If Swank were to issue $500,000 in debt, buying back half of its stock, then the firms

situation would change as follows:

406

Titman/Keown/Martin

B.

all-equity financing

debt amount =

$0

EBIT $100,000

less interest expense

$0

earnings before tax $100,000

less taxes at 35% ($35,000)

net income $65,000

50% debt financing

debt amount = $500,000

debt rate =

5%

EBIT $100,000

less interest expense ($25,000)

earnings before tax $75,000

less taxes at 35% ($26,250)

net income $48,750

debt ratio =

0%

interest payments

$0

total distributions $65,000

debt ratio =

50%

interest payments $25,000

total distributions $73,750

interest tax savings =

$8,750

C. If Swank issues $500,000 of debt at 5%, its annual interest charges will be ($500,000) (.05)

= $25,000. This interest amount is deducted from the firms EBIT before taxes are computed,

so that taxable income is lowered by $25,000, and the tax due is lowered by ($25,000) (35%)

= $8,750. By paying $8,750 less in taxes, Swank can distribute $8,750 more to its funding

sources. Thus, in the debt scenario, total distributions rise by $8,750, from $65,000 to $73,750.

Are the stockholders better off after the debt issuance? Heres what theyve done: theyve

increased their return on their equity from ($65,000/$1,000,000) = 6.5% to ($48,750/$500,000) =

9.75%. Theyve reduced their distribution by 25%, but reduced their investment by twice that

(50%). These are the effects of leverage. In exchange for a boosted return, they have increased

their risk. Whether or not this makes them better off depends on their risk tolerance.

However, they have certainly managed to recoup for themselves (in relative terms) some of

the dollars that they used to send to the government.

D. If there were no corporate taxes on income, our analysis would look like this:

all-equity financing

debt amount =

$0

EBIT $100,000

less interest expense

$0

earnings before tax $100,000

less taxes at 0%

$0

net income $100,000

debt ratio =

0%

interest payments

$0

total distributions $100,000

debt amount = $500,000

debt rate =

5%

EBIT $100,000

less interest expense ($25,000)

earnings before tax $75,000

less taxes at 0%

$0

net income $75,000

407

debt ratio =

50%

interest payments $25,000

total distributions $100,000

interest tax savings =

$0

In this case, distributions to the firms funding sources total $100,000 in both cases, higher

than the total distributions before; since there is no outflow for taxes, all of the firms earnings

accrue to its funding sources. However, there are no interest tax savings, since there is no tax

subsidy for debt financing. This is the initial Modigliani and Miller result discussed in the text

at the beginning of Section 15.2: Without taxes, the cash flows that a firm generates are

independent from its capital structure. Thus, Swank makes $100,000 that is available for

distribution; the amount of debt it has only changes the names on some of the checks.

The equityholders still experience effects of leverage, since they reduce their financing by

half, but reduce their distribution by only 25% (as before). Their return on equity is now 15%.

They are able to finance half of the firm for the 5% required by debtholders instead of the 10%

return required by equityholders. We can explain this by looking at equation 15-6: If the initial

return to the unlevered firm was 10% ($100,000/$1,000,000), then the cost of equity for the

levered firm should be:

D

ke = kunlevered + (kunlevered kd )

E

$500,000

= 10% + (10% 5%)

= 15%.

$500,000

Note that in the first case, we did not have this same result: There, the return to equity rose

from 6.5% to 9.75%. If we had used equation 15-6, we would have predicted an increase to

only 8%: 6.5% + (6.5% 5%) ($500,000/$500,000). In that case, the extra boost came from

the interest tax savings. By saving $8,750 in taxes, the equityholders boosted their return by

$8,750/$500,000 = 1.75%, accounting for their total 9.75% return.

408

15-9.

Titman/Keown/Martin

As shown in Step 3 of Checkpoint 15.1, the times interest earned ratio is calculated like this:

times interest earned = (EBIT/interest expense).

For Home Depot, we find this as (using 2008 as an example):

$7,316,000

times interest earned =

= 10.51.

$696,000

Thus, in 2008, Home Depot earned enough operating income to pay its interest charges 10.51

times. The comparable values for 2007 and 2006, respectively, are 24.74 and 65.91.

While each of these values suggests that Home Depot is able to pay it debt comfortably, the trend

is worrisome. Between 2006 and 2008, its times-interest-earned ratio fell by 84%. Whats going

on? First, Home Depots EBIT fell by 22% over this period, so that the firm was less effectively

generating operating income. Second, its use of debt increased: Its interest charges rose 387%.

Having more fixed obligations and less operating income is not a recipe for success. Home Depot

should examine carefully the erosion in its EBIT, then evaluate its use of debt, given the trend it

finds.

70

$12,000,000

60

$10,000,000

50

$8,000,000

40

EBIT

$6,000,000

interest expense

30

$4,000,000

20

$2,000,000

10

$0

2006

2007

2008

409

15-10. As shown in Step 3 of Checkpoint 15.1, the times interest earned ratio is calculated like this:

times interest earned = (EBIT/interest expense).

For Lowes, we find this as (using 2008 as an example):

$4,750,000

times interest earned =

= 19.87.

$239,000

Thus, in 2008, Lowes earned enough operating income to pay its interest charges 19.87 times.

The comparable values for 2007 and 2006, respectively, are 33.45 and 29.46. Lowes most recent

times-interest-earned ratio is therefore the lowest of the most recent three years. Its trend has also

been downward, falling in each of the years; 2008s ratio is about 1/3 lower than 2006s, although

its 2008 EBIT is slightly higher. This is because Lowes debt charges have risen significantly over

the period (by 51%).

We can visualize Lowes situation using the chart below:

40

$6,000,000

35

$5,000,000

30

$4,000,000

25

20

$3,000,000

EBIT

interest expense

times interest earned

15

$2,000,000

10

$1,000,000

$0

2006

2007

2008

Lowes has a much more stable pattern than Home Depot did. While Lowes earnings fell in 2008

from 2007, it was not as precipitous a decline as Home Depots. Also, Lowes does not exhibit the

persistent decline in the times-interest-earned (TIE) ratio that plagued Home Depot. Lowes is

more easily able to service its debt than is Home Depot: a slower decline in revenue, a slower rise

in debt, and a resulting slower decline in TIE.

410

Titman/Keown/Martin

15-11. If sales increase 25%, and assuming that variable costs remain at ($22.8/$45.75) = 49.84% of

sales, then we find that net income rises 46.27%, while EBIT rises 41.73%. The effect on net

income is magnified, since the interest charges incurred by the firm do not rise as EBIT rises. We

see these effects in reverse when sales fall by 25%. The larger effect on net income is an example

of the leverage effect discussed in section 15.4 of the text.

sales

variable costs

revenue before fixed costs

fixed costs

EBIT

less interest expense

earnings before taxes

less taxes @ 50%

net income

% change in net income:

% change in EBIT:

current

$45,750,000

$22,800,000

$22,950,000

$9,200,000

$13,750,000

$1,350,000

$12,400,000

$6,200,000

$6,200,000

increase

sales

25%

$57,187,500

$28,500,000

$28,687,500

$9,200,000

$19,487,500

$1,350,000

$18,137,500

$9,068,750

$9,068,750

46.27%

41.73%

decrease

sales

25%

$34,312,500

$17,100,000

$17,212,500

$9,200,000

$8,012,500

$1,350,000

$6,662,500

$3,331,250

$3,331,250

-46.27%

-41.73%

%

49.84%

If the firm reduces its leverage, it will change this leverage effect. The effects on EBIT are

unaffected, of course, but now we see that net income rises 51.71% (more than the initial 46.27%)

when sales rise by 25%, and falls 40.83% (less than the initial 46.27%) when sales fall 25%. With

lower interest charges, more of the firms operating cash flows flow through to the equityholders.

sales

variable costs

revenue before fixed costs

fixed costs

EBIT

less interest expense

earnings before taxes

less taxes @ 50%

net income

% change in net income:

% change in EBIT:

current

$45,750,000

$22,800,000

$22,950,000

$9,200,000

$13,750,000

$1,350,000

$12,400,000

$6,200,000

$6,200,000

increase

sales

25%

$57,187,500

$28,500,000

$28,687,500

$9,200,000

$19,487,500

$675,000

$18,812,500

$9,406,250

$9,406,250

51.71%

41.73%

decrease

sales

25%

$34,312,500

$17,100,000

$17,212,500

$9,200,000

$8,012,500

$675,000

$7,337,500

$3,668,750

$3,668,750

-40.83%

-41.73%

411

15-12. We can solve for the EBIT indifference point using equation 15-10:

( EBIT $0) (1 0.40) ( EBIT $120,000) (1 0.40)

=

.

80,000

40,000

Solving, we find that EBIT = $240,000. We can prove this by looking at the pro forma income

statements for each plan:

EBIT

less interest expense

earnings before taxes

less taxes @ 40%

net income

# of common shares

EPS

stock plan

$240,000

$0

$240,000

($96,000)

$144,000

80,000

$1.80

stock/debt plan

$240,000

($120,000)

$120,000

($48,000)

$72,000

40,000

$1.80

We can also see this by using a chart like Figure 15.7 from the text:

$6.00

$5.00

EPS

$4.00

$3.00

stock plan

stock/debt plan

$2.00

$1.00

$0.00

$0

$50,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000 $450,000 $500,000

EBIT

The black dashed lines show that the two plans schedules cross when EBIT = $240,000; at that

level of operating earnings, the two plans generate the same EPS, $1.80.

15-13. As in Problem 15-12, we can begin to compare the two financing plans by finding the break-even

level of EBIT, using equation 15-10. We first must determine the number of shares that would be

used under the two plans, however. Under Plan A, the all-equity plan, the firm would raise

$2,000,000 with shares valued at $20 each, requiring a total of 100,000 shares. For the stock/debt

plan, because half of the money needed would be raised through debt, the firm would need to issue

only ($1,000,000/$20) = 50,000 shares, assuming the same stock price of $20. Now, we can find

the break-even EBIT:

Titman/Keown/Martin

=

.

100,000

50,000

Solving, we find that EBIT = $220,000. We can prove this by looking at the pro formas:

EBIT

less interest expense

earnings before taxes

less taxes @ 30%

net income

# of common shares

EPS

stock plan

$220,000

$0

$220,000

($66,000)

$154,000

100,000

$1.54

stock/debt plan

$220,000

($110,000)

$110,000

($33,000)

$77,000

50,000

$1.54

$6.00

$5.00

$4.00

EPS

412

$3.00

stock plan

stock/debt plan

$2.00

$1.00

$0.00

$0

$50,000

EBIT

Note that, as with the case in Problem 15-12, the stock/debt plan performs better when EBIT is

higher: it benefits from leverage. However, at lower levels of EBITspecifically, below the break

even of $220,000, the firm is better off using no debt.

If the firm is confident that its EBIT will be greater than $300,000/year, comfortably above the

break-even EBIT point, then it should use the stock/debt plan. Since the firm will have no trouble

making the interest payments, it can benefit from leverage. Fewer shares outstanding, plus interest

tax savings generated from safe debt, mean a higher EPS for shareholders.

413

15-14. First, we assume that the dollar amounts given in Problems 15-10 and 15-11 are in thousands, so

that we measure the two companies net income in billions of dollars. (A quick check on

Yahoo!Finance verifies this assumption.) We therefore start here:

HOME DEPOT

EBIT for 2008 = $7,316,000,000

interest expense = $696,000,000

# of shares = 1,700,000,000

net income = $4,210,000,000

EPS =

$2.48

LOWE'S

EBIT for 2008 = $4,750,000,000

interest expense = $239,000,000

# of shares = 1,460,000,000

net income = $2,809,000,000

EPS =

$1.92

Home Depots EPS is higher. To find the breakeven level of EBIT, we can modify our

interpretation of equation 15-10; instead of considering each side of the equation to represent a

financing plan were evaluating (as in Problems 15-12 and 15-13), we will consider each to be a

description of one of our firms:

( EBIT $696,000,000) (1 0.35) ( EBIT $239,000,000) (1 0.35)

=

.

1,700,000,000

1,460,000,000

EBIT

less interest expense

earnings before taxes

less taxes @ 35%

net income

# of common shares

EPS

HD

($2,541,083,300)

$696,000,000

($3,237,083,300)

$1,132,979,155

($2,104,104,145)

1,700,000,000

($1.24)

LOW

($2,541,083,300)

$239,000,000

($2,780,083,300)

$973,029,155

($1,807,054,145)

1,460,000,000

($1.24)

Titman/Keown/Martin

$5.00

$4.00

$3.00

$2.00

EPS

414

$1.00

Home Depot

Lowe's

$0.00

($6,000,000,000)

($4,000,000,000)

($2,000,000,000)

$0

$2,000,000,000

$4,000,000,000

$6,000,000,000

$8,000,000,000

($1.00)

($2.00)

($3.00)

EBIT

As long as the firms have positive EBIT, Lowes performs better for its shareholders, generating

higher EPS for every level of EBIT.

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