Question

If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

True or False?

Answer 1

True

Step-by-step explanation:

It is easier to explain following an example:

EBIT 100

debt interests 25

shares outstanding 500

No change scenario -10% EBIT +10% EBIT

EBIT 100 90 110

interests (25) (25) (25)

net income 75 65 85

earnings per share 0.15 0.13 0.17

change - -13.3% +13.3%

A 10% EBIT decrease will result in a 13.3% decrease in earnings per share, while a 10% EBIT increase will result in a 13.3% increase in earnings per share.