EBIT/EPS ANALYSIS

EBIT-EPS analysis is an approach which helps in designing the optimum capital structure for the company or the firm.

To design various alternatives of debt, equity and preference shares in order to maximize the EPS at a given level of EBIT.

It examines how different capital structures affect earnings available to shareholders (Earning Per Share). It is the analysis of the effect of financing alternatives on earnings per share. To design the capital structure of the firm in such a way so as to minimize the cost of capital. EBIT-EPS analysis is a method to

Sales (-)V.C =Contribution (-)F.C :

: :

xxxxx xxx xxxx

xxxxx :

=EBIT {Earning Before Interest and Taxes}

EBIT (-)INTERSET =EBT (-)TAX

: :

xxxxx : xxxxx : : :

xxx xx

=Earning for ESH () No. of E.S

xxxxx xxx

= EPS {Earning Per Share} xxx

Q: The present capital structure of Gupta Co. ltd. is: 4000, 5% Debentures of Rs 100 each Rs 4,00,000 2000, 8% P. Shares of Rs 100 each Rs 2,00,000 4000, Equity shares of Rs 100 each Rs 4,00,000 Rs 10,00,000 The present earning of the company before interest & taxes are 10% of the invested capital every year. The company is in need of Rs 2,00,000 for purchasing a new equipment and it is estimated that additional investment will also produce 10% earning before interest & taxes every year. The company has asked your advice as to whether the requisite amount be obtained in the form of 5% Debenture or 8% P. Shares Or equity shares of Rs 100 each to be issued at par. Examine the problem in all its bearing and advice firm if the Corporate tax rate is 50%.

STATEMENT SHOWING THE EPS UNDER EXISTING & PROPOSED ALTERNATIVE ALTENATIVES
Particular s EBIT (-)Interest EBT (-)Tax 50% EAT (-)P. Dividend ESH
() No. Equity Shares of

Present 1,00,000 20,000 80,000 40,000 40,000 16,000 24,000 4,000 Rs 6.00 -

i ii Debenture P. Share 1,20,000 30,000 90,000 45,000 45,000 16,000 29,000 4,000 Rs 7.25 +1.25 1,20,000 20,000 1,00,000 50,000 50,000 32,000 18,000 4,000 Rs 4.50 -1.50

iii Eq. Share 1,20,000 20,000 1,00,000 50,000 50,000 16,000 34,000 6,000 Rs 5.67 -0.33

EPS

Change in EPS

 The EBIT level at which the EPS is the same for two alternative financial plan is referred to as the indifference point/level. Financial break even point obtained by a company at a given level of EBIT for which the firms EPS is zero. If EBIT is less than financial break even point, then the EPS is negative. If EBIT is more than the financial break even point, then more and more fixed cost financing option can be used by a

APPROACHES TO INDIFFERENCE ANALYSIS Graphical approach Algebric approach

EPS 3

BREAKEVEN EBIT

Debt + Equity alternative Equity Alternative

2 1 0 $1m $2m

Indifference point

$3m

$4m

EBIT

Algebric approach
Breakeven analysis

For newly formed company: X(1-T) (X-I)(1-T) Equity vs. Debenture = = N1 N2 X(1-T) X(1-I)-P Equity vs. P. Shares = = N1 N3 X(1-T) (X-1)(1-I)-P Equity vs. P. Shares vs. Debenture= = N1 N4 For an existing company: outstanding} (X-1)(1-T) N1 {When debenture are = (X-I 1 )(1-T)-P N4

Where, X = EBIT N1 = No. of Eq. shares outstanding if any eq. shares are issued N2 = No. of Eq. shares outstanding if both eq. shares & debt are issued N3 = No. of Eq. shares outstanding if both eq. & pref. shares are issued N4 = No. of Eq. shares outstanding if both pref. shares & debt are issued I = Interest on debentures P = Pref. Dividend T = Corporate Tax Rate

REFERENCES:
KHAN, M.Y. & JAIN, P.K.; FINANCIAL MANAGEMENT (TATA MC GRAW- HILL PUBLISHING CO. LTD.),1995

PANDEY, I.M.; FINANCIAL MANAGEMENT (VIKAS PUBLISHING HOUSE LTD.), 2007 SAHNI, D.; BUSINESS NATH RAM NATH), 2009 FINANCE (KEDAR