PBIT - EPS Analysis

Existing capital structure of Falcon Limited: 1 million equity shares of Rs. 10 each
Tax structure: 50%
plans to raise additional capital of Rs. 10 million
Evaluation of two financing plans: issue of equity shares (1 million equity shares of Rs. 10 each) or iss
Equity Financing
Debt Financing
PBIT: 2,000,000
PBIT: 4,000,000PBIT: 2,000,000
PBIT: 4,000,000
Interest
profit before taxe
taxes
profit after tax
no. of equity shar
earnings per shar

2,000,000
1,000,000
1,000,000
2,000,000
0.50

4,000,000
2,000,000
2,000,000
2,000,000
1.00

1,400,000
600,000
300,000
300,000
1,000,000
0.30

1,400,000
2,600,000
1,300,000
1,300,000
1,000,000
1.30

LEVERAGE ANALYSIS

OPERATING LEVERAGE:
finex limited which is currently selling a product at Rs 1000 per unit has VC of Rs. 500 per unit and FC
earnings before interest and taxes is as follows:

Revenues
variable operating costs
Fixed operating costs
Earnings before interest and taxe

500 units
500,000
250,000
200,000
50,000

600 units
600,000
300,000
200,000
100,000

20% increase in sales leads to a 100% increase in PBIT, similarly a small decline in sales leads to a lar
A high DOL, other factors held constant, implies that a relatively small change in sales results in a larg
The sensitivity of PBIT to changes in unit sales is referred to as the degree of operating leverage
When a high percentage of total costs are fixed, the firm is said to have a high DOL

FINANCIAL LEVERAGE
Finex Limited currently has an PBIT of Rs. 50,000.
Fixed expenses: Rs. 30,000
Tax rate: 50%
Outstanding shares: 10,000
EPS at two levels of PBIT is shown as follows:
CASE A (in Rs.)CASE B (in Rs.)
Profit before interest and taxes
50,000
60,000
Interest expense
30,000
30,000
Profit before taxes
20,000
30,000
Tax
10,000
15,000
Profit after taxes
10,000
15,000
Earnings per share
1
1.50
20% increase in PBIT leads to a 50% increase in PBIT

The use of debt concentrates the firm's business risk on the stockholders, known as financial leverage
Hence, financial leverage is the extent to which fixed income securities (debt and preferred stock) are

The sensitivity of profit before tax to changes in PBIT is referred to as the degree of financial levera

f Rs. 10 each) or issue of 14% debentures

500 per unit and FC of Rs. 200,000.

n sales leads to a large decline of ROE

ales results in a large change in ROE
erating leverage

as financial leverage
preferred stock) are used in a firm's capital structure
of financial leverage

OPERATING LEVERAGE (page 422)

Plan A
Price
Variable Costs
Fixed costs
Equity
Tax rate

Plan B

$2
$2
$1.50
$1
$20,000 $60,000
$200,000 $200,000
40%
40%

CALCULATE BREAK-EVEN POINT FOR BOTH PLANS

WHAT IS THE OPERATING PROFIT IN THE FOLLOWING SCENARIOS?
SALES
40,000 UNITS
100,000 UNITS
160,000 UNITS
200,000 UNITS

UNITS
SOLD
POOR
NORMAL
WONDERFUL
EXCELLENT

PLAN A OPERATIN NET

OPERATI
NG
G
INCOM
DOLLAR
COSTS
PROFITS
E
SALES

40,000 80,000
100,000 200,000
160,000 320,000
200,000 400,000

80,000
170,000
260,000
320,000

0
0
30,000 18,000
60,000 36,000
80,000 48,000

ROE
0%
9%
18%
24%

PLAN B OPERATIN NET

G
INCOM
OPERATIN
E
G COSTS PROFITS
100,000
160,000
220,000
260,000

-20,000
40,000
100,000
140,000

ROE

-12,000 -0.60%
24,000
12%
60,000
30%
84,000
42%