EBIT-EPS and capital structure Data-Check is considering two capital structures.

Question

EBIT-EPS and capital structure Data-Check is considering two capital structures. The key information is shown in the following table. Assume a 40% tax rate. Calculate two EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values. Plot the two capital structures on a set of EBIT-EPS axes. Indicate over what EBIT range, if any each structure is preferred. Discuss the leverage and risk aspects of each structure. If the firm is fairly certain that its EBIT will exceed $75,000, which structure would you recommend? Why?

Explanation / Answer

Particulars Structure A Structure B EBIT 100000 100000 Less :Interest on Coupon Bonds 16000 34000 EBT 84000 66000 Tax 33600 26400 EAT 50400 39600 No of Shares 4000 2000 EPS 12.6 19.8 EBIT 200000 200000 Less :Interest on Coupon Bonds 16000 34000 EBT 184000 166000 Tax 73600 66400 EAT 110400 99600 No of Shares 4000 2000 EPS 27.6 49.8 c) Both Structures are preffered at the Range of EBIT with $200000, as it gives the Highest EPS at that range d)Structure A has More of Equity and Less of debt funds, due to which the EPS reduces in Value, as compared to Structure B, as the No. of shares are More, also Stucture B has more of Debt Funds and Lesser Equity funds, but if the EBIT reaches a Low of less than $50000 in case of Structure B, the EPS will be lower as most of the EBIT will be needed to cover the interest expense. e) I would recommend structure B as The EPS will be more than Structure A as worked out above

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