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A study of capital structure performance using EBIT-EPS analysis

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  1. Abstract
  2. Introduction
  3. Need for the study
    1. Scope of study
    2. Limitations of the study
    3. Primary sources
  4. Review literature
    1. Capital structure analysis
    2. Factors affecting the capital structure
    3. Features of an optimal capital structure
  5. Capital structure and firm value
    1. The capital structure decision process
    2. Capital structure and planning
    3. Features of an appropriate capital structure
    4. Approaches to establish appropriate capital
  6. The capital structure controversy
    1. Net income approach
    2. Net operating income approach
    3. Traditional approach
    4. Cost of capital and valuation approach
    5. Cash flow approach
  7. Financing decision
  8. Strategies in finance mobilization
  9. Limitation of ELPS as financing
    1. Decision criterion
    2. EPS variability and financial risk
  10. Ffinancial leverage
    1. Definition
    2. Meaning of financial leverage
    3. Financial leverage and the shareholders risk
    4. Operating risk
    5. The variability of EBIT
    6. Financial risk
    7. Measures of financial leverage
    8. Financial leverage and the share holders return
  11. Combined effect of operating and financial leverages
  12. Ratio analysis
    1. Capital structure ratios
  13. Biblography

This study is born out of the need to establish the presence of the responsiveness of capital structure performances through EBIT-EPS analysis as performances indicators to turnovers the company's performances, which is measure of leverage, ratios with respect to the company's needs.

Capital structure is one of the most complex areas of financial decision making. Poor capital structure decision can result in a high cost of capital .effective capital structure decision can lower the cost of capital.

The Company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits. While deciding on the appropriate capital structure for an organization, the first thing is to understand the affect on Earning Per Share (EPS) due to the changes in Earning Before Interest and Taxes (EBIT) under different financing alternatives.

EBIT - Earnings Before Interest and Taxes. Accountants like to use the term for this income statement item, but finance people usually refer to it as EBIT. Either way, on an income statement, it is the amount of income that a company has after subtracting operating expenses from sales .Another way of looking at it is that this is the income that the company has before subtracting interest and taxes (hence, EBIT).

EPS - Earnings per Share. This is the amount of income that the common stockholders are entitled to receive (per share of stock owned). This income may be paid out in the form of dividends, retained and reinvested by the company, or a combination of both.
One way of determining the right mix of capital is to measure the impacts of different financing plans on Earnings per Share (EPS). The objective is to find the level of EBIT (Earnings before Interest Taxes) and EPS (earnings per share). Our results reveal that performances indicators used in our study are significantly sensitive to the capital structure for most of the companies considered in or study.
We computed the degree of leverage, rations & percentage change in EBIT ?EPS in order to achieve our study of objectives.

[...] The EBIT-EPS approach to capital structure involves selecting the capital structure that maximizes EPS over an expected range of earnings before interest and taxes. This analysis discloses the effect of different financing plans on EPS at various levels of EBIT To analysis the effects of a firm's capital structure on the owners returns, between EBIT and EPS is considered. EBIT is used where constant business risk is assumed. EPS is used to measure the owner's returns which are expected to be closely related to the share price We determining the right mix of capital are to measure the impacts of different financing plans on Earnings per Share (EPS). [...]

[...] The existence of an optimum capital structure is not accepted by all. These exist two extreme views and middle position. David Durand identified the two extreme views the net income and net operating approaches NET INCOME APPROACH: Under the net income approach the cost of debt and cost of equity are assumed to be independent to the capital structure. The weighted average cost of capital declines and the total value of the firm rise with increased use of leverage NET OPERATING INCOME APPROACH: Under the net operating income (NOI) approach, the cost of equity is assumed to increase linearly with average. [...]

[...] According to ?gestunberg? capital structure refers to the composition or make of the firm's capitalization and it includes all long-term capital resources. It represents the mix of different sources of long-term funds, retained in the total capitalization of the company 1. The firm uses only two sources of funds that are equity and debt there would be no change in the investment decision of the firm 3. The firm distributes the entire profits among the shareholders to show that There are no retained earnings the total financing remains constant 5. [...]

[...] Thus these exists an optimum capital structure at which the cost of capital is minimum. The logic of this view is not very sound. The MM Position changes when corporate taxes are assumed. The interest tax shield resulting from the use of debt adds to the value of the firm. This advantage reduces the when personal income taxes are concerned. CAPITAL STRUCTURE MATTERS: THE NET INCOME APPROACH: The essence of the net income approach is that the firm can increase its value or lower the overall cost of capital by increasing the proportion of debt in the capital structure .The crucial assumptions of this approach are: The use of debt does not change the risk perception of investors; as a result, The equity capitalization rate, Kc and the debt capitalization rate, Kd, Remain constant with changes in leverage. [...]

[...] The capital structure decision is a significance managerial decision, which influences and return of the investors. The company will have to plan its capital structure at the time of promotion itself and also subsequently whenever it has to raise additional funds for various new projects. Wherever the company needs to raise finance, it involves a capital structure decision because it has to decide amount of finance to be raised as well as the sources it is to be raised. Capital Structure Defined: The assets of a company can be financed either by increasing the owners claims or the creditors claim. [...]

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