Chapter11

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Unformatted text preview: ,000 bond with a 10% (annual) coupon rate of interest and an issue of 600 shares of $4 (annual dividend per share) preferred stock outstanding. It also has 1,000 shares of common stock outstanding. The annual interest on the bond issue is $2,000 (0.10 $20,000). The annual dividends on the preferred stock are $2,400 ($4.00/share 600 shares). Table 11.6 presents the EPS corresponding to levels of EBIT of $6,000, $10,000, and $14,000, assuming that the firm is in the 40% tax bracket. Two situations are shown: Case 1 A 40% increase in EBIT (from $10,000 to $14,000) results in a 100% increase in earnings per share (from $2.40 to $4.80). Case 2 A 40% decrease in EBIT (from $10,000 to $6,000) results in a 100% decrease in earnings per share (from $2.40 to $0). The effect of financial leverage is such that an increase in the firm’s EBIT results in a more-than-proportional increase in the firm’s earnings per share, whereas a decrease in the firm’s EBIT results in a more-than-proportional decrease in EPS. TABLE 11.6 The EPS for Various EBIT Levelsa Case 2 Case 1 40% EBIT 40% $6,000 $10,000 2,000 2,000 2,000 $...
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This document was uploaded on 03/30/2014.

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