Question

For an all-equity firm: (a) as earnings before interest and taxes (EBIT) increase, the earnings per share (EPS) increases by the same percentage. (b) as EBIT increases, the EPS increases by a larger percentage. (c) as EBIT increases, the EPS decreases at the same rate. (d) as EBIT increases, the EPS decreases by a larger percentage. (e) as EBIT increases, the EPS might either increase or decrease

Answer 1

(a) as earnings before interest and taxes (EBIT) increase, the earnings per share (EPS) increases by the same percentage.

Step-by-step explanation:

Since the firm has no debt and no preferred stocks, EBIT is just EBT (earnings before taxes). So any change in EBIT (or EBT) will change earnings per share in the same proportion.

For example:

EBIT = $200

outstanding shares = 100

taxes = 25%

EPS = ($200 x 75%) / 100 = $1.50 per share

if EBIT increases by 50% to $300

EPS = ($300 x 75%) / 100 = $2.25 per share

EBIT increased by 50% and EPS also increased by 50%