Untitled-29

(^318) Financial Management
Less dividends preference shares - 1,30,000
Earnings for equity holders 2,92,500 1,75,500
Number of equity shares 20,000 12,000
EPS 14.625 14.625
Graphic Approach The indifference point can also be determined graphically. Figures 1
and 2 portray the graphic representation of financial plans (i) and (ii) of Example 7. The
horizontal X-axis represents EBIT while EPS is represented on the Y-axis.
In order to graph the financial plan, two sets of EBIT-EPS coordinates are required.
The EPS values associated with EBIT values of Rs 2,00,000 and Rs 6,00,000 are
calculated and plotted on the graph paper under each financial plan in case of Figure 1.
It may noted that 100 per cent equity inancing plan starts from origin (O) because EPS
would be zero if EBIT is zero. However, EBIT required to have the value of the EPS
as zero is Rs 1,50,000, that is, the interest charges payable on 105 debentures of Rs
15,00,000. Therefore, the starting point of 50 per cent equity financing plan is away
from the point of the origin (i.e. it starts from Rs 1.5 lakh). The point at which the two
lines intersect is the indifference point (IP). When we draw a perpendicular to the X-
axis from the point of intersection, we have EBIT required for the IF. A line drawn
from the point of intersection and joined with the Y-axis determines the EPS at the
indifference point -
Figure 1: EBIT-EPS Analysis
An important point to be remembered in relation to the drawing of 33 per cent preference
share financial plan (Fig. 2) is that EPS would not be zero if the firm's EBIT is Rs
1,30,000, because dividend payable on preference share is not tax-deductible. The firm
must earn so much more than
Rs 1,30,000 that it is left with Rs 1.30,000 after paying taxes. This amount can be
calculated dividing by (1- t). The required amount Is Rs 2,00,000 (Rs 1,30,000) ̃
Equity
Advantage
Equity
Advantage
Debt + Equity
Alternative
Equity Alternative
Indifference point
EPS (Rs)
19.5
13
6.5