Question

Consider two companies in a world with no taxes that are alike except in borrowing choices. Company 1 has no debt​ financing, and Company 2 uses debt financing. The EBIT for both companies is​ $1,000. Company 1 has 500 shares outstanding and pays no interest. Company 2 has 300 shares outstanding and pays​ $250 in interest. What is the EPS for each​ company?

Answer 1

Company 1 = $2 per share

Company 2 = $2.50 per share

Step-by-step explanation:

Given that,

EBIT for both companies = $1,000

Number of shares outstanding for company 1 = 500

Number of shares outstanding for company 2 = 300

Interest paid by company 2 = $250

EPS for company 1:

= (Total income - Preferred dividend) ÷ Shares outstanding

= ($1,000 - $0) ÷ 500

= $2 per share

EPS for company 2:

= (Total income - Preferred dividend) ÷ Shares outstanding

= ($1,000 - $250) ÷ 300

= $750 ÷ 300

= $2.50 per share