The document discusses various approaches to determine an appropriate capital structure, focusing on the EBIT-EPS approach which aims to maximize earnings per share (EPS) against different levels of debt and equity. It highlights the importance of analyzing capital structures, potential trade-offs, and the implications of leverage on earnings. Additionally, it notes the drawbacks of the EBIT-EPS approach, particularly its tendency to overlook risk premiums associated with increased debt.

1. APPROACHES TO
DETERMINEAPPROPRIATE
CAPITALSTRUCTURE- EBIT –
EPSAPPROACH
Submitted & prepared by:
Amandeep Thakur
(Asst.Prof in PG deptt of commerce)
DAV college Hoshiarpur

2. APPROACHES TO DETERMINE
APPROPRIATE CAPITAL
STRUCTURE
• EBI T – EPSApproach
• ValuationApproach
• Cash FlowApproach

3. EBI T – EPS Approach –
• The EPS-EBIT approach to capital structure involves selecting the
capital structure that maximizes EPS over the expected range of
EBIT.
• Using ths approach, the emphasis is on maximizing the owners
returns (EPS).
• The EBIT-EPS approach can help balance a company's debt with its
equity.
• Effective business management requires careful planning and
decision-making about the balance of debt and equity used in
financing the business.

4. EBI T – EPS Approach –
• The EBIT-EPS approach is one method available to managers
to guide them in making decisions about capital structure.
• The EBIT-EPS approach is one tool managers use to decide on
the right mix of debt and equity financing in a business's
capital structure.
• To benefit from the EBIT-EPS approach, it helps to understand
the basics of how it works, as well as its advantages and
drawbacks.

5. EBI T – EPS Approach –
• In the EBIT-EPS approach, the business plots graphs of its
performance at different possible debt-to-equity ratios, such as
40 percent debt to 60 percent equity.
• In a basic graph, the earnings per share as a data point is
plotted for each level of earnings before interest and taxes at
different debt-to-equity ratios.
• The graph is then analyzed to determine the ideal level of debt-
to-equity for the business.

6. EBIT/EPS ANALYSIS
• It design various alternatives of debt, equity and preference shares in
order to maximize the EPS at a given level of EBIT.
• It examines how different capital structures affect earnings available
to shareholders (Earning Per Share).
• It is the analysis of the effect of financing alternatives on earnings
per share.
• To design the capital structure of the firm in such a way so as to
minimize the cost of capital.
• EBIT-EPS analysis is a method to study the effect of leverage under
alternative methods of financing.

7. CALCULATION OF EBIT:
Sales : xxxxx
(-)V.C : xxx
=Contribution : xxxxx
(-)F.C : xxxx
=EBIT {Earning Before Interest andTaxes}

8. CALCULATION OF EPS:
EBIT : xxxxx
(-)INTERSET : xxx
=EBT : xxxxx
(-)TAX : xx
=Earning for ESH : xxxxx
(÷) No. of E.S : xxx
= EPS {Earning Per Share} xxx

9. EBIT – EPS BREAK EVEN ANALYSIS:
• The EBIT level at which the EPS is the same for two
alternative financial plan is referred to as the indifference
point/level.
• Financial break even point obtained by a company at a given
level of EBIT for which the firm’s EPS is zero.
• If EBIT is less than financial break even point, then the EPS is
negative.
• If EBIT is more than the financial break even point, then more
and more fixed cost financing option can be used by a firm.

10. DRAWBACKS
• The EBIT-EPS approach is not always the best tool for making
decisions about capital structuring.
• The EBIT-EPS approach places heavy emphasis on maximizing
earnings per share rather than controlling costs and limiting risk.
• It's important to keep in mind that as debt financing increases,
investors should expect a higher return to account for the greater
risk; this is known as a risk premium.
• The EBIT-EPS approach does not factor this risk premium into the
cost of financing, which can have the effect of making a higher level
of debt seem more advantageous for investors than it actually is.

11. LEVERAGE
Leverage is the employment of an asset/source of finance for
which firm pay fixed cost/fixed return. It may of three types:
• Operating Leverage
• Financial Leverage
• Combined Leverage

12. OPERATING LEVERAGE
• It may be defined as the firm’s ability to use fixed operating
costs to magnify the effects of changes in sales on its earnings
before interest and taxes.
• Operating leverage is associated with investment (assets
acquisition) activities.
• Degree of Operating Leverage (DOL) = Percentage change in
EBIT / Percentage change in sales

13. FINANCIAL LEVERAGE
• Financial leverage is the ability of the firm to use fixed
financial charges to magnify the effects of changes in EBIT on
the firm’s earnings per share.
• Degree of financial leverage (DFL)= Percentage change in
EPS divided by Percentage change in EBIT

14. COMBINED LEVERAGE
• The degree of combined leverage may be defined as the
percentage change in EPS due to the percentage change in
sales.
• Thus the combined leverage is:
CL
%Changein EBIT
%changein sales
*
%Changein EPS
%Changein EBIT
%changein EPS
%Changesales

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