Ebit Eps Analysis
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 earnings before interest and taxes, would ensure the largest EPS.
Generally cost of debt is lower than cost of equity. Therefore raising debt (trading onequity) increases EPS and it gives benefit to the shareholders. However, excess of debt will create more risk and therefore it is not advisable. A firm can identify an ideal level of quantum of debt and equity so that it is within proportion.
EBIT can be calculated by subtracting variable and fixed cost from net sales.
EPS can be obtained by dividing the result of tax and interest subtracted from EBIT by No. of shares.
i.e EPS = [( EBIT – I ) ( 1 – T ) – PREF] / S
EXAMPLE 1: A company with long-term capitalization of $ 10 million consisting entirely of common stock wishes to raise another $5 million for expansion through one of the three possible financing plans.The company may finance with 1.All common stock 2.All debt at 9% 3.All preferred stock with 7% dividend EBIT is $ 1,400,000 and tax rate is 50%. 200,000 shares of stock are presently outstanding.Common stock can be sold at $ 50 per share.( 100,000 additional shares) To determine the EBIT breakeven, EPS is calculated for a hypothetical level of EBIT. In this example, the hypothetical level of EBIT is $
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 earnings before interest and taxes, would ensure the largest EPS.
Generally cost of debt is lower than cost of equity. Therefore raising debt (trading onequity) increases EPS and it gives benefit to the shareholders. However, excess of debt will create more risk and therefore it is not advisable. A firm can identify an ideal level of quantum of debt and equity so that it is within proportion.
EBIT can be calculated by subtracting variable and fixed cost from net sales.
EPS can be obtained by dividing the result of tax and interest subtracted from EBIT by No. of shares.
i.e EPS = [( EBIT – I ) ( 1 – T ) – PREF] / S
EXAMPLE 1: A company with long-term capitalization of $ 10 million consisting entirely of common stock wishes to raise another $5 million for expansion through one of the three possible financing plans.The company may finance with 1.All common stock 2.All debt at 9% 3.All preferred stock with 7% dividend EBIT is $ 1,400,000 and tax rate is 50%. 200,000 shares of stock are presently outstanding.Common stock can be sold at $ 50 per share.( 100,000 additional shares) To determine the EBIT breakeven, EPS is calculated for a hypothetical level of EBIT. In this example, the hypothetical level of EBIT is $