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CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Capital Structure

Which of the following is a recognised limitation of using EBIT-EPS analysis alone to choose a capital structure?

A key limitation of EBIT-EPS analysis is that it ignores the financial risk from higher leverage. It focuses only on EPS at various EBIT levels and does not consider how added debt raises the cost of equity and the chance of insolvency.

  1. AIt ignores the risk associated with higher financial leverageCorrect
  2. BIt cannot be computed when debt is used
  3. CIt ignores interest on debt
  4. DIt assumes the firm has no equity shares

Explanation

EBIT-EPS analysis compares EPS under alternative financing plans but does not account for the greater financial risk and likely rise in cost of equity as debt increases. It does include interest and works with debt and equity, so the other options are incorrect.

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