ASSIGNMENT: EBIT-EPS ANALYSIS

Answer the following questions (1-6) based on the summary P&L statement given below
Rs. Crores
Sales
500
Variable Costs
300
Contribution
200
Fixed Costs
100
EBIT
100
Interest @10% p.a.
50
PBT
50
Taxes @30%
15
PAT
35
Number of equity shares (crore)
50
Face value of shares (Rs.)
10
Debt
500
1. What is the degree of operating leverage of this company? Answer: 2
2. What is the degree of financial leverage of this company? Answer: 2
3. If the sales of this company increase by 1%, what would the percentage change in PAT be?
Answer: +4%
4. What is the EPS of this company? Answer: Rs. 0.70
5. The company is undertaking a new project involving capital expenditure of Rs. 50 crores. It is
considering two options for raising the funds required for the new project:
(i)

Issue of equity shares @ Rs. 10 per share

(ii)

Raising debt @ 10% p.a.

What is the EBIT at which the EPS of the company would be the same under both options?
Assume that the tax rate would remain the same. Answer: Rs. 105 crores
6. If the EBIT of the company is higher than this indifference point, which financing option is better
from the perspective of improving EPS? Answer: The debt option

7. What is the degree of operating leverage of a firm which has annual sales of Rs. 150 crores,
variable costs of Rs. 50 crores, and fixed costs of Rs. 50 crores? Answer: 2
8. What is the degree of financial leverage of an unlevered firm with EBIT of Rs. 50 crores, and tax
rate of 30%? Answer: 1
9. What is the EPS of a company which makes a profit after tax of Rs. 10 crores, and has 1 crore
shares of face value of Rs. 10 each outstanding?

Answer: Rs. 10

10. A firm has a degree of operating leverage of 1.64 and a degree of financial leverage of 1.42?
What is the degree of total leverage of the firm? Answer: 2.23
11. Company A-Coffee Ltd needs Rs 10 lakh for expansion of one of its warehouses. Its financial
advisor has suggested that the expansion is expected to yield an annual EBIT of Rs 160,000. In
choosing a financial plan, A-Coffee Ltd has an objective of maximizing EPS. It is considering
the possibility of issuing equity shares and raising debt of Rs 100,000, or Rs 400,000 or Rs
600,000. The current market price per share is Rs 25 and is expected to drop to Rs 20, if funds are
borrowed in excess of Rs 500,000. Funds can be borrowed at the rates indicated below:
a) Up to Rs 100,000 at 8% p.a.
b) Over Rs 100,000 up to Rs 500,000 at 12% p.a.
c) Over Rs 500,000 at 18%p.a.
Assume a tax rate of 50%. Determine the EPS for the three financing alternatives.
Answer: EPS for Alternative I Rs, 2.11, Alternative II Rs. 2.42, Alternative III Rs. 2.15