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    Capital Structure Policy I Ebit-Eps Analysis: Page 1 of 2

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    Danzo Shah
    This document discusses capital structure policy and analysis using three concepts: 1. EBIT-EPS analysis compares financing alternatives under various EBIT assumptions to determine the option with the highest EPS. 2. Financial break-even point is the EBIT level needed to cover fixed financial costs like interest and dividends. EBIT below this level results in negative EPS. 3. Indifference point is the EBIT level beyond which financial leverage provides EPS benefits, where EPS is equal for two financing plans.

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    Capital Structure Policy I Ebit-Eps Analysis: Page 1 of 2

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    Danzo Shah
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    This document discusses capital structure policy and analysis using three concepts: 1. EBIT-EPS analysis compares financing alternatives under various EBIT assumptions to determine the option with the highest EPS. 2. Financial break-even point is the EBIT level needed to cover fixed financial costs like interest and dividends. EBIT below this level results in negative EPS. 3. Indifference point is the EBIT level beyond which financial leverage provides EPS benefits, where EPS is equal for two financing plans.

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    This document discusses capital structure policy and analysis using three concepts: 1. EBIT-EPS analysis compares financing alternatives under various EBIT assumptions to determine the option with the highest EPS. 2. Financial break-even point is the EBIT level needed to cover fixed financial costs like interest and dividends. EBIT below this level results in negative EPS. 3. Indifference point is the EBIT level beyond which financial leverage provides EPS benefits, where EPS is equal for two financing plans.

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    75 views2 pages

    Capital Structure Policy I Ebit-Eps Analysis: Page 1 of 2

    Uploaded by

    Danzo Shah
    This document discusses capital structure policy and analysis using three concepts: 1. EBIT-EPS analysis compares financing alternatives under various EBIT assumptions to determine the option with the highest EPS. 2. Financial break-even point is the EBIT level needed to cover fixed financial costs like interest and dividends. EBIT below this level results in negative EPS. 3. Indifference point is the EBIT level beyond which financial leverage provides EPS benefits, where EPS is equal for two financing plans.

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    Capital Structure Policy

    I 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. The choice of the
    combination of the various sources would be one which, given the level of earnings before interest and
    taxes, would ensure the largest EPS.

    1. Suppose a firm has a capital structure exclusively comprising of equity shares amounting to Rs. 10, 00,000.
    The firm now wishes to raise additional Rs. 10, 00,000 for expansion. The firm has four alternative financial
    plans:
    (a) It can raise the entire amount in the form of Equity Share Capital.
    (b) It can raise 50% as Equity Share Capital and 50% as 5% Debentures.
    (c) It can raise the entire amount as 6% Debentures.
    (d) It can raise 50% as Equity Share Capital and 50% as 5% Preference Share Capital

    Further assume that the existing EBIT are Rs. 1, 20,000, the tax rate is 35%, outstanding equity shares
    10,000 and the market price per share is Rs. 100 under all four alternatives.

    Which financing plan should the firm select?

    II FINANCIAL BREAK EVEN POINT

    Financial BEP is the level of EBIT which is equal to firm’s fixed financial costs. In other words, it I the level of
    EBIT at which the firm can satisfy all fixed financial charges (i.e. interest and preference dividend). EBIT less
    than this level will result in negative EPS.

    Financial break-even point = I + Dp/(1-t)


    Where, I = Annual interest charges
    Dp = Preference Dividend and
    t = Tax rate

    2. For illustration 1 calculate financial break even point

    III INDIFFERENCE POINT

    Indifference point is the EBIT level beyond which benefits of financial leverage accrue with respect to EPS.
    The EBIT level at which the EPS is the same for two alternative financial plans is referred to as the
    indifference point/level.

    X = EBIT at the indifference point


    N1 = no. of equity shares outstanding if only equity shares are issued
    N2 = no. of equity shares outstanding if both debentures and equity shares are issued
    N3 = no. of equity shares outstanding if both preference and equity shares are issued

    Page 1 of 2
    N4 = no. of equity shares outstanding if both preference shares and debentures are issued
    I = interest on debentures
    Dp = Preference Dividend
    t = corporate income tax
    Dt = tax on preference dividend

    3.

    4.
    A firm’s sales, variable costs and fixed cost amount to Rs. 75, 00,000, Rs. 42, 00,000 and Rs. 600,000
    respectively. It has borrowed Rs. 45, 00,000 at 9% and its equity capital totals Rs. 55, 00,000.
    (a) What is the firm’s ROI?
    (b) If the sales drop to Rs. 50,00,000, what will the new EBIT be?
    (c) At what level will the EBT of the firm equal to zero?
    (d) At what level of EBIT and Sales, EPS of the firm will be equal to zero?

    Page 2 of 2

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