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31 July, 16:43

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?

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  1. 31 July, 17:13
    0
    True

    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.
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