EBIT-EPS analysis is used to examine the effect of alternative plans of capital financing on the firms earnings per share (EPS), assuming a range of values for the firms level of earnings before interest and taxes (EBIT). The results can be generated and presented using either a mathematical or a graphical solution.

What information is needed to perform an EBIT-EPS analysis? Check all that apply.

Projections regarding the firms future EBIT levels

The EBIT-EPS indifference point

A graph with the firms EBIT as the X-axis scale and the firms EPS as the Y-axis scale

The current and expected future prices per share of the firms preferred stock

An important piece of information produced by the EBIT-EPS analysis is the level of EBIT at which two possible financing plans generate the same EPS, such that a decision maker would be indifferent between the two plans.

Consider the case of Carter Chemical Company.

Carter Chemical Company is an unlevered firm currently earning an EBIT of $10 million, with 3 million shares of common stock outstanding and a tax rate of 40%. In anticipation of making a major acquisition, Carter is evaluating whether to finance its future growth using either the sale of $20 million of new 10% bonds (Plan 1) or the issuance of 2 million new shares of common stock at $10 per share (Plan 2).

The firms EBIT-EPS indifference point corresponds to an EBIT of $__________? and an EPS of $_____________?

Earlier today, Carters CFO and her staff developed two postacquisition forecasts of the firms expected EBIT. If the economy and the acquisition are expected to perform poorly, Carters EBIT is expected to be $3 million, but if the economy and the acquisition are expected to perform well, the EBIT is expected to be $15 million. One of the staff members used this projected EBIT data and the corresponding EPS values to generate the following EBIT-EPS graph. Examine the graph and use it to answer the questions that follow.

Tool tip: Mouse over the points on the graph to see their coordinates.

024681012141618204.03.53.02.52.01.51.00.50EPS(Dollars)EBIT(Millions of dollars)Plan1(Debt)Plan2(Equity)EBIT-EPS Indifference Point

Which financing plan should be recommended if Carter expects an EBIT of $12 million? _____________ should be recommended, because ______________ for the specified level of EBIT.

Choices are: Plan 1, Plan 2, or Either plan

Then: It generates higher EPS, it generates lower EPS, or they produce the same EPS