TAXES. I. Accountants like to use the term net operating income for this income statement item, WHY? Because
II. It is the amount of income that a company has after
subtracting operating expenses from sales (hence the term net operating income).
III. Finance people usually refer to it as EBIT on an income
statement.
IV. Another way of looking at it is that is the income that
the company has before subtracting interest and taxes (hence EBIT). 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). EARNING AFTER TAX
Accountants call this net income or net profit
after taxes.
But finance people usually refer to it is a EAT
E Earning A - After T - Tax DECISION ABOUT RAISE ADDITIONAL MONEY When company wants to raise additional money by issuing following three aspects Equity Capital Preference Stock Debt or Debenture which alternative will allow company to have the highest earnings per share. At that time company assume assume a certain level of sales calculate our estimated EBIT will be for each alternative form of financing HOW TO TAKE DECISION For example, 1. Current financed entirely with common stock, the firm has 2000 shares of common stock outstanding. 2. Currently pays no common stock dividend, all earnings are retained and reinvested into the company. 3. Needs to raise Rs 50000 in new money. As financial manager. 4. 35% tax. . To raise the Rs 50000 we considering the three alternatives. 1. common stock- the company can sell additional shares at the current price of Rs 50 per share. (50*1000=50000). 2. Preferred stock- dividend on preferred stock is 7.3% of the raised money. 3. Debt- interest rate on debt is 4%. EBIT 10000 COMMON STOCK PREFFERENCE DEBT STOCK EBIT 10000 10000 10000 -INTEREST(4%) - - -2000 EBT 10000 10000 8000 - TAX (35%) -3500 -3500 -2800 EAT 6500 6500 5200 PREFERRED 0 -3650 - DIVIDEND (7.3%) EAT COMMON 6500 2850 5200 NO OF SHARE 3000 2000 2000 EPS 2.17 1.43 2.6 DECISION
If the expected level of EBIT
1. 6000: indifference point
2. Less then 6000: Company would tend to use
common stock financing. . 3. Above 6000: Company would tend to use debt financing. INDIFFERENCE POINT The level of earnings before interest and tax (EBIT) at which the earnings per share are the same irrespective of the proportion of debt and equity.
If the firm attains this particular level of EBIT, the firm
need not bother about the debt-equity mix, since the EPS will remain constant.
Every financial plan is equally desirable whether it
suggests 100% equity or 50-50 sharing between the two or, for that matter, any other proportion between debt and equity.