1. EBIT/EPS Analysis The tax benefit of debt Trade-off theory Practical considerations in the determination of capital structure CAPITAL STRUCTUR E Lecture 2
2.
3.
4.
5.
6.
7.
8.
9. EBIT/ EPS analysis Current versus Proposed Current (no debt) Proposed (with debt) EPS 8 6 4 2 0 -2 -4 3 6 9 10 12 15 18 EBIT For EBIT up to £ 10m, e quity financing is best For EBIT greater than £ 10m, debt financing is best
14. The impact of financial leverage EPS U 1.5 3.0 4.5 EPS L 0.5 3.5 6.5 Spread U 3.0 Spread L 6.0 … t hat’s RISK EBIT 50% EBIT 50% BELOW ABOVE EXPECTED EXPECTED EXPECTED
15.
16.
17.
18. Firm U nlevered Firm L evered No debt $10,000 of 12% Debt $20,000 Equity $10,000 in Equity 40% tax rate 40% tax rate The tax benefit of debt Both firms have same business risk and EBIT of $3,000. They differ only with respect to use of debt. U has $20K in Eq uity & L has $10K in Eq uity
19. EBIT $3,000 $3,000 Interest 0 1,200 EBT $3,000 $1,800 Taxes (40%) 1 ,200 720 NI $1,800 $1,080 ROE 9.0 % 10.8 % Firm U Firm L U; 1.8/20K = 9 % L; 1.08 / 10K = 10.8 % The tax benefit of debt
![Capital structure ,[object Object],[object Object],[object Object],[object Object],[object Object]](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)