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EBIT-EPS (or Indifference) Analysis:Different financing decisions will have differing impacts on EPS. We can examine the effects of various financing alternatives through an EPS-EBIT analysis, which involves determining the crossover or 'indifference' EBIT at which the EPS is the same between two financing alternatives. Suppose that the firm is comparing the two possible capital structures, 1 and 2. Then, EBIT*, the indifference EBIT, is such that whereEBIT* =the indifference EBITI = the interestsT= tax rateDP = the dividends for the preferred sharesN = the number of shares outstandingIn the absence of tax and preferred shares in the capital structure of the firm, the above expression becomes Other Capital Structure Analysis Tools:(1) Coverage ratios.(2) Lender requirements or debt covenants (3) Bond ratings (4) Industry norms(5) Detailed cash flow analysis including sensitivity and scenario analysis
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PRESENTED BY:GYANDEEP KUMARMBA 2nd SEM
EBIT-EPS EBIT-EPS analysis 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 study the effect of leverage under alternative methods of financing.
Sales : xxxxx(-)V.C : xxx
=Contribution : xxxxx(-)F.C : xxxx
=EBIT {Earning Before Interest and Taxes}
EBIT : xxxxx(-)INTERSET : xxx
=EBT : xxxxx(-)TAX : xx
=Earning for ESH : xxxxx(÷) No. of E.S : xxx
= EPS {Earning Per Share} xxx
Q: The present capital structure of Gupta Co. ltd. is:4000, 5% Debentures of Rs 100 each Rs 4,00,0002000, 8% P. Shares of Rs 100 each Rs 2,00,0004000, Equity shares of Rs 100 each Rs 4,00,000
Rs 10,00,000The 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. SharesOr 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
Particulars Present
iDebenture
iiP. Share
iiiEq. Share
EBIT(-)Interest
1,00,00020,000
1,20,00030,000
1,20,00020,000
1,20,00020,000
EBT(-)Tax 50%
80,00040,000
90,00045,000
1,00,00050,000
1,00,00050,000
EAT(-)P. Dividend
40,00016,000
45,00016,000
50,00032,000
50,00016,000
ESH(÷) No. of Equity Shares
24,0004,000
29,0004,000
18,0004,000
34,0006,000
EPSChange in EPS
Rs 6.00-
Rs 7.25+1.25
Rs 4.50-1.50
Rs 5.67-0.33
ALTENATIVES
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 firm’s 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 firm.
APPROACHES TO INDIFFERENCE ANALYSIS
•Graphical approach•Algebric approach
BREAKEVEN BREAKEVEN EBITEBITEPSEPS
EBITEBIT$1m $2m $3m $4m$1m $2m $3m $4m
Debt + EquityDebt + Equityalternativealternative
EquityEquityAlternative Alternative
00
33
22
11
Indifference pointIndifference point
Algebric approachBreakeven analysis
For newly formed company:
Equity vs. Debenture =
Equity vs. P. Shares =
Equity vs. P. Shares vs. Debenture=
For an existing company: {When debenture are outstanding}
X(1-T) N1
=(X-I)(1-T) N2
X(1-T) N1
=X(1-I)-P N3
X(1-T) N1
=(X-1)(1-I)-P N4
(X-1)(1-T) N1
=(X-I1)(1-T)-P N4
Where,X = EBITN1 = No. of Eq. shares outstanding if any eq. shares are issuedN2 = No. of Eq. shares outstanding if both eq. shares & debt are issuedN3 = No. of Eq. shares outstanding if both eq. & pref. shares are issuedN4 = No. of Eq. shares outstanding if both pref. shares & debt are issuedI = Interest on debenturesP = Pref. DividendT = 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 FINANCE (KEDAR NATH RAM NATH), 2009