Presentation on

EBIT/EPS Analysis

Introduction
EBIT

- Earnings Before Interest and Taxes. It is the amount of income that a company has after subtracting operating expenses from sales. Another way of looking at it is that this is the income that the company has before subtracting interest and taxes.

 EPS

- Earnings Per Share. This is the amount of income that the common stockholders are entitled to receive (per share of stock owned). This income may be paid out in the form of dividends, retained and reinvested by the company, or a combination of both. (It is pronounced E, P, S).

Analysis
The

need to raise additional money by issuing either debt, preferred stock, or common stock. & choosing the best alternative which will allow us to have the highest earnings per share. This situation calls for an EBIT/EPS analysis. This means that we will calculate what our earnings per share will be at various levels of sales (and EBIT).which will guide us the best in decision making.

EBIT-EPS Break-Even, or Indifference, Analysis

EBIT-EPS Break-Even Analysis Analysis of the effect of financing alternatives on earnings per share. The break-even point is the EBIT level where EPS is the same for two (or more) alternatives.

Calculate EPS for a given level of EBIT at a given financing structure.

EPS = (EBIT I) (1 t) Pref. Div. # of Common Shares

EBIT-EPS Chart
Basket Wonders has $2 million in LT financing (100% common stock equity).
Current

common equity shares = 50,000 $1 million in new financing of either: All C.S. sold at $20/share (50,000 shares) All debt with a coupon rate of 10% All P.S. with a dividend rate of 9% Expected EBIT = $500,000 Income tax rate is 30%

EBIT-EPS Calculation with New Equity Financing

Common Stock Equity Alternative
EBIT $500,000 Interest 0 EBT $500,000 Taxes (30% x EBT) 150,000 EAT $350,000 Preferred Dividends 0 EACS $350,000 # of Shares 100,000 EPS $3.50 $150,000* 0 $150,000 45,000 $105,000 0 $105,000 100,000 $1.05

* A second analysis using $150,000 EBIT rather than the expected EBIT.

EBIT-EPS Chart
6

Earnings per Share ($)

5 4 3 2 1 0 0 100 200 300 400 500 600 700

Common

EBIT ($ thousands)

EBIT-EPS Calculation with New Debt Financing

Long-term Debt Alternative
EBIT $500,000 Interest 100,000 EBT $400,000 Taxes (30% x EBT) 120,000 EAT $280,000 Preferred Dividends 0 EACS $280,000 # of Shares 50,000 EPS $5.60 $150,000* 100,000 $ 50,000 15,000 $ 35,000 0 $ 35,000 50,000 $0.70

* A second analysis using $150,000 EBIT rather than the expected EBIT.

EBIT-EPS Chart
6

Debt
Indifference point between debt and common stock financing

Earnings per Share ($)

5 4 3 2 1 0 0

Common

100

200

300

400

500

600

700

EBIT ($ thousands)

EBIT-EPS

(or Indifference) Analysis:

Different

financing decisions will have differing impacts on EPS. We can examine the effects of various financing alternatives through an EPS-EBIT analysis, which involves determining the crossover or 'indifference' EBIT at which the EPS is the same between two financing alternatives.

Suppose that the firm is comparing the two possible capital structures, 1 and 2. Then, EBIT*, the indifference EBIT, is such that

EPS1 EPS 2
( EBIT* I1 )(1 T ) Dp1 N1 ( EBIT* I 2 )(1 T ) Dp 2 N2

where

EBIT* =the indifference EBIT I = the interests T= tax rate DP = the dividends for the preferred shares N = the number of shares outstanding

 In

the absence of tax and preferred shares in the capital structure of the firm, the above expression becomes

EBIT I1 EBIT I 2 N1 N2
* *

conclusion
The

EBIT-EPS approach helps financial managers examine the impact of financial leverage as a financing method. Investment performance is crucial to the successful application of any leveraging strategy.

Thank

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