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Unformatted text preview: to know at least two EBIT–EPS coordinates.
The approach for obtaining coordinates can be illustrated by an example.
EXAMPLE The current capital structure of JSG Company, a soft-drink manufacturer, is as
shown in the following table. Note that JSG’s capital structure currently contains
only common stock equity; the firm has no debt or preferred stock. If for convenience we assume the firm has no current liabilities, its debt ratio (total
liabilities total assets) is currently 0% ($0 $500,000); it therefore has zero
financial leverage. Assume the firm is in the 40% tax bracket. Current capital structure
Long-term debt $ Common stock equity (25,000 shares @ $20)
Total capital (assets) 0 500,000
$500,000 EBIT–EPS coordinates for JSG’s current capital structure can be found by
assuming two EBIT values and calculating the EPS associated with them.14
Because the EBIT–EPS graph is a straight line, any two EBIT values can be used
to find coordinates. Here we arbitrarily use values of $100,000 and $200,000. EBIT (assumed) $100,000 $200,000 $0 debt) 0 0 Net profits before taxes $100,000 $200,000 40,000 80,000 $ 60,000 $1...
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This document was uploaded on 03/30/2014.
- Spring '14