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Operating and Financial Leverage^85

This line shows the earnings per share associated with each level of EBIT. It is

interesting to note that the line intersects the EBIT axis at Rs.6,000. This value of EBIT

represents the level at which the firmís earnings per share are equal to zero. This zero

intercept can be verified by looking at Case 2 in Table 3.1. At levels of EBIT below

Rs.6,000, the firm would have negative EPS. This portion of the graph has not been

included.

A graphical illustration of different degrees of financial leverage The type of graphical

presentation in Figure 3.7 can be used to illustrate differences in financial leverage.

Suppose we want to compare the financing plan in the preceding example with an

alternate plan. The alternate plan involves Rs. 20,000 of 5-percent debt, 250 shares of

Rs. 4 preferred stock,

Figure 3.1: A Graphical presentation of a financing plan

and 2,000 shares of common stock. The annual interest payment will be Rs.1,000 (.05

◊ Rs.20,000) and the annual preferred dividend payment will be Rs.1,000 (Rs.4/sh. ◊

250 sh.). in order to graph this plan, two sets of EBIT -EPS coordinates are required.

The EPS associated with EBIT values of Rs.10,000 and Rs.14,000 are calculated

below.

40%

Rs. Rs.

EBIT 10,000 14,000

I 1,000 1,000

EBT 9,000 13,000

ñT (50%) 4,500 6,500

ñP 1,000 1,000

EPC 3,500 3,500

EPS

Rs. 1. 75 /sh

2 , 000

Rs. 3 , (^500) =
Rs. 2. 75 /sh
2 , 000
Rs. 5 , (^500) =
+56%
Financing Plan
EBIT(Rs)
EPS (Rs.)
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