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Question

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

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

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 = [(20000060000) (1-0.5) -0]/ 10000 = Rs.7
Rs.12
Alternative 2 EPS = [(20000048000) (1-0.5) -0]/ 10000 = Rs.7.6



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