Question

Under which situation the EPS of the company falls with increase use of debt? explain with an example.

Answer 1

When the amount of debt increases then it will lead to increase in interest payments. Since, earnings of shareholders are residual earnings (i.e profit- interest payments) so EPS of the company will fall. For instance, profit of a company is Rs 20 lakhs and interest payment increases from 20,000 to 40,000 then EPS=Net profit after tax/number of equity shares. ​
Suppose, there are 100 equity shareholders in the company then EPS will decrease from Rs 1,800 to 1,400.