Question

For a constant EBIT, if the debt level is further increased then ____________.

• A. EPS will always increase
• B. EPS may increase
• C. EPS will never increase
• D. None of the above

Answer 1

The correct option is B EPS may increase

For a constant EBIT, if the debt level is further increased then EPS may increase but only if the the rate of interest of debenture decreases simultaneously.

Formula for calculation of EPS = [(X-I) (1-T)- PD] /N ,

Where,

X= EBIT

I1= Fixed Interest

T= Tax rate

PD= Preference dividend if any

N1 = Number of shares

s.100 Alternative 1 : EBIT is $Rs.200000$ , amount of debenture is $Rs.500000$, interest on the same is @ $12$ % and the number of equity share is $10000$ and the tax rate is $50$%

Alternative 2 : EBIT is $Rs.200000$ , amount of debenture is $Rs.600000$, interest on the same is @ $8$ % and the number of equity share is $10000$ and the tax rate is $50$%

So now,

Alternative 1 EPS = [($200000-60000$) ($1$-$0.5$) -$0$]/ $10000$ = $Rs.7$

Rs.12

Alternative 2 EPS = [($200000-48000$) ($1$-$0.5$) -$0$]/ $10000$ = $Rs.7.6$