Untitled-29

Capital Structure Theories^311

Rs 25,000, Rs 60,000 and Rs 38,462 respectively. This level of EBIT may be termed as
financial break even level of earnings before interest and tares because it represents
the level of EBIT necessary for the firm to break even on its fixed financial charge. In
other words, it is the level of EBIT at which the firm can satisfy all fixed financial
charges (i.e. interest and preference dividend). EBIT less than this level will result in
negative EPS. The financial break-even point can be determined by Eq.

Financial break-even point =
 

, +

+

where I = Annual interest charges

PD = Preference dividend

t = Tax rate

Equation gives before-tax earnings necessary to cover the firm's fixed financial
obligations. As fixed financial charges are added, the break-even point for zero EPS is
increased by the amount of the additional fixed cost. Beyond the financial break-even
point, increase in EPS is more than the proportionate increase in EBIT.

(i) Rs 80,000 (4 per cent return on total assets)

(ii) 1,00,000 (5 per cent return on total assets)

(iii) 1,30,000 (6.5 per cent return on total assets)

(iv) 1,60,000 (8 per cent return on total assets)

(v) 2,00,000 (10 per cent return on total assets)

Table: EBIT-EPS Analysis under Various EBIT

Assumptions for the four Financing Plans

(i) EBTT a Re 80,000 (4 per cent return on investments) Financing Plans

A B C D

EBIT 80,000 80,000 80,000 80,000

Less interest - 25,000 60,000 -

EBT 80,000 55,000 20,000 80,000

Less taxes 28,000 19,250 7,000 28,000

EAT 52,000 35,750 13,000 52,000

Less preference dividend - - - 25,000

Ear for equity number 52,000 35,750 13,000 27,000
EPS 2.6 2.38 1.3 1.8