Introduction to Finance

EBIT/eps analysis 
allows 
managers to see how diff erent 
capital structures aff ect the earnings 
and risk levels of their fi rms
TA B L E 1 8 . 3
Current and Proposed Capital Structures for the Bennett Corporation
Current
Proposed
Total assets 
$100 million 
$100 million
Debt 
0 million 
50 million
Equity 
100 million 
50 million
Common stock price 
$25
$25
Number of shares 
4,000,000
2,000,000
Interest rate 
10%
10%
13
By cross-multiplying, 2 EBIT = 4 EBIT – 20. Solving for EBIT, we obtain EBIT = 10.

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18.6 EBIT/Eps Analysis
583
leveraged capital structure will have the higher earnings per share. When EBIT is less 
than $10 million, the current, less-leveraged capital structure will have the higher earn-
ings per share.
The indiff erence level of $10 million in EBIT did not occur by chance. It equals the fi rm’s 
interest cost of 10 percent multiplied by its total assets ($100 million). In other words, if the 
fi rm can earn an operating return on assets (EBIT/TA) greater than its interest cost, leverage is 
benefi cial in that it results in higher earnings per share. If the fi rm’s operating return on assets 
is less than its 10 percent interest cost, leverage is expensive relative to the fi rm’s earning abil-
ity and results in lower earnings per share. If Bennett believes EBIT will meet expectations at 
$12 million, the proposed capital structure change is attractive.
Implications of EBIT/Eps Analysis
EBIT/eps analysis has several practical implications. First, as seen, it shows the EBIT ranges 
where a fi rm may prefer one capital structure over another. The fi rm may decide to increase 
or decrease its fi nancial leverage, depending on whether its expected EBIT is above or below 
the indiff erence EBIT level.