#2 EBIT - EPS Analysis (Earning Per Share) - Financial Management ~ B.COM / BBA / CMA

Understanding Capital Structure and EBIT EPS Analysis

Capital structure is a combination of long-term sources of capital, such as debt, equity, and preference shares.
The finance manager can decide the proportion of each capital source to raise funds for the business.
The optimum capital structure is the combination of capitals where the cost of capital is minimum and the value of the firm is maximized.
The wealth of equity shareholders is maximized when the earning per share (EPS) or market price per share is maximum.
To determine the optimum capital structure, the finance manager calculates the cost of capital and performs EBIT EPS analysis.
EBIT EPS analysis helps in calculating EPS or market price per share based on different capital structures.
The problem involves a company called At Sir Limited that wants to raise an additional 30 lakh rupees by issuing equity shares with a face value of 10 rupees each.
The company already has 60,000 equity shares issued.

EPs (Earnings Per Share) is calculated by dividing the earnings available to equity shareholders by the number of equity shares.
The number of equity shares is important in the calculation of EPs.
In the first plan, where no equity shares are being issued, the number of equity shares to be considered is the existing number of equity shares in the company.
The company wants to raise 30 lakh rupees and has provided four different plans for fund raising.
The first plan involves raising the entire amount through debentures carrying 10% interest.
The second plan involves raising the entire amount through equity.
The third plan involves raising 20 lakh rupees through equity shares and 10 lakh rupees through debentures carrying 10% interest.
The fourth plan involves raising 10 lakh rupees through equity shares and 20 lakh rupees through preference shares carrying a specified interest percentage.

The question provides information on interest rate, dividend rate, and tax rate.
The task is to deduct the tax and calculate the EPS.
The analysis involves creating a table for EPS analysis.
The table includes columns for each capital structure and a total column.
The first step is to determine the EBIT for each capital structure.
The calculation for EPS is done for each EBIT value.
Four capital structures are considered: all equity, 10% debentures, 20% equity and 10% debentures, and 10% equity and 20% preference shares.
Interest and preference dividends are deducted based on the capital structure.
Interest is deducted only for plans with debentures, while preference dividends are deducted only for plans with preference shares.
The table helps in comparing the EPS for different capital structures and selecting the one with the highest earning per share.

EBIT (Earnings Before Interest and Taxes) is calculated by subtracting the interest expense from the total revenue.
The interest expense is calculated by multiplying the amount of debentures raised by the interest rate.
If there are no debentures in a particular plan, no interest expense is deducted.
For plans where capital is raised from equity and preference shares, no interest expense is deducted as these do not incur interest payments.
The EBT (Earnings Before Taxes) is the same as the EBIT, except for deducting the tax expense.
The tax expense is calculated by multiplying the EBT by the tax rate.
Subtracting the tax expense from the EBT gives the final EBIT after tax deduction.

Deduct preference dividend from earnings before tax.
Calculate preference dividend based on the amount borrowed from preference shareholders.
Deduct interest and tax from the resulting figure.
The remaining amount is the earnings available to equity shareholders.
Divide earnings available to equity shareholders by the number of equity shares to calculate EPS.
Consider the number of equity shares already issued in the business when calculating EPS for each plan.

Determine the number of equity shares already in the business.
Calculate the EBIT (Earnings Before Interest and Taxes) for each investment option.
Deduct the interest paid on borrowed funds from the EBIT to obtain EBT (Earnings Before Tax).
Calculate the tax amount based on the EBT and the given tax rate.
Deduct the preference dividend from the EBT to obtain the earning available to equity shareholders.
Divide the earning available to equity shareholders by the number of equity shares, considering the already issued shares.
Determine the EPS (Earnings Per Share) for each investment option.
Select the investment option with the highest EPS.

Consider the already issued shares when calculating the number of equity shares.
Deduct interest on borrowed amount, minus tax, and minus preference dividend to calculate the available funds for equity shareholders.
Compare the wealth of equity shareholders in each plan to determine if it is maximized.
Divide the number of equity shares to calculate EPS.
Select the plan with the highest EPS as the best option.