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CMA Intermediate · Financial Management and Business Data Analytics · Leverage Analyses and EBIT - EPS Analysis

Using the indifference point of ₹3,60,000 between an all-equity plan and a debt-equity plan, Kaveri Industries expects EBIT of ₹6,00,000 consistently. Which conclusion follows from EBIT-EPS analysis?

Choose the debt plan. When expected EBIT exceeds the indifference point, the more leveraged plan yields higher EPS because earnings on borrowed funds exceed interest cost. At ₹6,00,000 versus ₹3,60,000, debt financing maximises EPS.

  1. AChoose the equity plan because EPS is higher above the indifference point
  2. BChoose the debt plan because EPS is higher above the indifference pointCorrect
  3. CBoth plans give equal EPS at this EBIT
  4. DChoose the debt plan because interest is tax deductible only below the indifference point

Explanation

Above the indifference EBIT, the plan with more financial leverage gives higher EPS because the cost of debt is less than the return earned on the funds. Expected EBIT of ₹6,00,000 exceeds ₹3,60,000, so debt is preferred on EPS grounds. Equality holds only at ₹3,60,000.

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