Ebit-Eps Analysis

Approaches to determine appropriate capital structure - EBIT-EPS Approch
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1. APPROACHES TO DETERMINE APPROPRIATE CAPITAL STRUCTURE- EBIT – EPS APPROACH Submitted & prepared by: Amandeep Thakur (Asst.Prof in PG deptt of commerce) DAV college Hoshiarpur

2. APPROACHES TO DETERMINE APPROPRIATE CAPITAL STRUCTURE • EBI T – EPS Approach • Valuation Approach • Cash Flow Approach

3. EBI T – EPS Approach – • The EPS-EBIT approach to capital structure involves selecting the capital structure that maximizes EPS over the expected range of EBIT. • Using ths approach, the emphasis is on maximizing the owners returns (EPS). • The EBIT-EPS approach can help balance a company's debt with its equity. • Effective business management requires careful planning and decision-making about the balance of debt and equity used in financing the business.

4. EBI T – EPS Approach – • The EBIT-EPS approach is one method available to managers to guide them in making decisions about capital structure. • The EBIT-EPS approach is one tool managers use to decide on the right mix of debt and equity financing in a business's capital structure. • To benefit from the EBIT-EPS approach, it helps to understand the basics of how it works, as well as its advantages and drawbacks.

5. EBI T – EPS Approach – • In the EBIT-EPS approach, the business plots graphs of its performance at different possible debt-to-equity ratios, such as 40 percent debt to 60 percent equity. • In a basic graph, the earnings per share as a data point is plotted for each level of earnings before interest and taxes at different debt-to-equity ratios. • The graph is then analyzed to determine the ideal level of debt- to-equity for the business.

6. EBIT/EPS ANALYSIS • It design various alternatives of debt, equity and preference shares in order to maximize the EPS at a given level of EBIT. • It examines how different capital structures affect earnings available to shareholders (Earning Per Share). • It is the analysis of the effect of financing alternatives on earnings per share. • To design the capital structure of the firm in such a way so as to minimize the cost of capital. • EBIT-EPS analysis is a method to study the effect of leverage under alternative methods of financing.

7. CALCULATION OF EBIT: Sales : xxxxx (-)V.C : xxx =Contribution : xxxxx (-)F.C : xxxx =EBIT {Earning Before Interest and Taxes}

8. CALCULATION OF EPS: EBIT : xxxxx (-)INTERSET : xxx =EBT : xxxxx (-)TAX : xx =Earning for ESH : xxxxx (÷) No. of E.S : xxx = EPS {Earning Per Share} xxx

9. EBIT – EPS BREAK EVEN ANALYSIS: • The EBIT level at which the EPS is the same for two alternative financial plan is referred to as the indifference point/level. • Financial break even point obtained by a company at a given level of EBIT for which the firm ’s EPS is zero. • If EBIT is less than financial break even point, then the EPS is negative. • If EBIT is more than the financial break even point, then more and more fixed cost financing option can be used by a firm.

10. DRAWBACKS • The EBIT-EPS approach is not always the best tool for making decisions about capital structuring. • The EBIT-EPS approach places heavy emphasis on maximizing earnings per share rather than controlling costs and limiting risk. • It's important to keep in mind that as debt financing increases, investors should expect a higher return to account for the greater risk; this is known as a risk premium. • The EBIT-EPS approach does not factor this risk premium into the cost of financing, which can have the effect of making a higher level of debt seem more advantageous for investors than it actually is.

11. LEVERAGE Leverage is the employment of an asset/source of finance for which firm pay fixed cost/fixed return. It may of three types: • Operating Leverage • Financial Leverage • Combined Leverage

12. OPERATING LEVERAGE • It may be defined as the firm ’s ability to use fixed operating costs to magnify the effects of changes in sales on its earnings before interest and taxes. • Operating leverage is associated with investment (assets acquisition) activities. • Degree of Operating Leverage (DOL) = Percentage change in EBIT / Percentage change in sales

13. FINANCIAL LEVERAGE • Financial leverage is the ability of the firm to use fixed financial charges to magnify the effects of changes in EBIT on the firm ’s earnings per share. • Degree of financial leverage (DFL)= Percentage change in EPS divided by Percentage change in EBIT

14. COMBINED LEVERAGE • The degree of combined leverage may be defined as the percentage change in EPS due to the percentage change in sales. • Thus the combined leverage is: CL  % Change in EBIT % change in sales * % Change in EPS % Change in EBIT  % change in EPS % Change sales

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