Question

At indifference level of EBIT, different capital have .

• A. Same EBIT
• B. Same EPS
• C. Same PAT
• D. Same PBT

Answer 1

The correct option is B Same EPS

At indifference level of EBIT, different capital have same EPS. Let us take a look at an example:

The formula for calculating the point of indifference is as follows

[(X-I1) (1-T)- PD] /N1 = [(X-I2) (1-T)- PD] /N2 ,

Where,

X= EBIT Indifference level

I1= Fixed Interest under alternative 1

I2= Fixed Interest under alternative 2

T= Tax rate

PD= Preference dividend if any

N1 = Number of shares in option 1

N2 = Number of shares in option 2

The investment required in the project is $Rs.1500000$. Interest on debenture capital is $12$% and the tax rate is $50$%. Face value of share is $Rs.100$ , the debt equity ratio is $1:2$ and EBIT indifference level is $Rs.180000$

Alternative 1: Raising the whole amount by equity share. So, shares to be issued would be $Rs.1500000$ / $100$ = $15000$ shares.

Alternative 2: Raising $500000$ by shares and $1000000$ by equity. So interest payable would be $500000$ x $12$ % = $60000$ and number of equity shares would be $1000000$ / $100$ = $10000$ shares. So now,

Alternative 1 EPS = [($180000-0$) ($1-0.5$)- $0$] / $15000$

= $Rs.6$

Alternative 2 EPS = [($180000-60000$) ($1-0.5$)- $0$] / $10000$

= $Rs.6$