Ebit Eps Analysis

1367 Words Aug 25th, 2012 6 Pages
EBIT-EPS analysis
The EBIT-EPS analysis, as a method to study the effect of leverage, essentially involves the comparison of alternative methods of financing under various assumptions of EBIT. A firm has the choice to raise funds for financing its investment proposals from different sources in different proportions. For instance, it can (i) exclusively use equity capital
(ii) exclusively use debt
(iii) exclusively use preference capital
(iv) use a combination of (i) and (ii) in different proportions
(v) a combination of (i), (ii) and (iii) in different proportions
(vi) a combination of (i) and (iii) in different proportions and so on. The choice of the combination of the various sources would be one which, given the level of
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A steeper slope also means a higher return, and that the company needs to earn less EBIT to produce greater EPS. The breakeven point is also important because it tells the business how much EBIT there must be to avoid losses, and varies at different proportions of debt to equity.
The EBIT level at which the EPS is the same for two alternative financial plan is referred to as the indifferencepoint/level.
There is no indifference point between debt and preferred.Debt alternative dominates preferred for all levels of EBIT( by a constant amount of earnings per share)

The indifference point between any two financing methods can be expressed mathematically: ( EBIT*- I1) (1-T)= (EBIT*- I2) (1-T) S1 S2 I1,I2= annual interest expenses or preferred dividends on a before tax basis S1,S2=number of common shares outstanding for methods 1 and 2. T= tax rate
Indifference level of EBIT between debt and common stock financing: ( EBIT*- 0) (1-0.50) = (EBIT* –450,000) (1-0.50) 300,000 200,000 EBIT*(0.5) (200,000) = (EBIT (0.50)-450,000 (0.50)) 300,000 100,000EBIT*=135,000,000 EBIT*= $ 1,350,000 The indifference point between debt and common alternatives is at $ 1,350,000. If EBIT is below this amount, common stock financing will give higher EPS. If EBIT is above this amount debt
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