EPS-EBIT
Strategic Management /
Ngozi Mbanugo
12-3-2016
Introduction
The Earnings per share (EPS) is an important statistics that shows the company’s ability and efficiency in using the shareholders’ wealth for business actions and plans. It reflects the degree of judicious use of shareholder’s money. Higher EPS shows better management and control over the money. Earnings before interest and taxes (EBIT) is also called operating income that is generated through operating activities of a firm. It highly depends upon the company’s operating efficiency and the sales and market strategy that affect the sales volume and so revenue.
There are several cases arises when the company needs money to finance its project. The project may be either of launching new products, expansion of current product mix, the establishment of a new business unit or acquiring the other’s business. Finance may be made through several alternatives such as; issuing the retained earnings, equity, debt or preference shares or a mix of them (Steve, 2003). It is then critical for a firm to select the best alternative of finance. Many influences regulate the choice of funding like the quantum of funds, existing capital structure, availability of resources, time needed to raise the fund, tax policy of the government and most important, cost of fund.
The cost of debt is lower than the cost of other sources of the fund but still, there must be a balance between the proportions of debt with other sources of finance in the capital structure. Higher debt may lead to a risk of insolvency and increase the burden of fixed obligation in terms of payment of interest and principal at maturity. That’s why most of the firm employs lower debt in its capital instead of a significant tax advantage by debt (Ju, Parrino, PoteshmanWeisbach, 2005). On the other hand, equity is assumed to be retained with the investors forever, and there is no such fixed obligations are attached, but rising of investment fund is costly and time-consuming (VIjaykumarPrabhakaran, 2013). The cost of equity has also been assumed to be costliest. Therefore, every source of finance has certain advantages and disadvantages. Therefore, the firm has to choose the source of funding that is cheaper as well as the capital structure should be maintained at an optimal level.
EPS – EBIT Analysis
EPS – EBIT Analysis in a tool of evaluating the different alternatives of finance to maximize the EPS at the different level of EBIT. Alternatively, EPS – EBIT analysis studies the effects of financial leverage on the EPS with varying level of EBIT or under alternative financial plans (Trisha, 2006). This report provides the scope of study the various levels of EPS under different financial programs at a different level of EBIT. Thus a firm may be able to select the excellent source of finance that maximizes the EPS. Comparative analyses, performance evaluation, determining the optimum mix of capitals are some of the advantages of EPS – EBIT analysis. However, it has certain disadvantages like non-consideration of risk and difficult to find the state of over-capitalization of the firm. Still, this tool is very significant for a better selection of the source of fund.
EPS – EBIT Analysis of Keurig Green Mountain Inc.
Following table shows the capital structure of firm over past three years –
Long term capitals / 2015 / 2014 / 2013Long term debt / 447.95 / 257.18 / 236.28
Equity / 2709.36 / 3458.68 / 2635.57
Debt/Equity / 0.1653 / 0.0744 / 0.0897
Source:
In 2015, the debt-equity ratio got doubled from 7.44% to 16.53%. Since, it is still quite low, there is no foreseeable risk of insolvency in near future.
The following table shows the tax structure from 2013 to 2015.
2015 / 2014 / 2013Income before tax ($ mil) / 750.58 / 924.37 / 740.87
Income after tax ($ mil) / 498.63 / 597.41 / 484.1
Tax rate / 0.3357 / 0.3537 / 0.3466
Average tax rate / 34.53%
Source:
The current EBIT is $16,170,000. Suppose, in recession, EBIT may decrease by 10% and in boom, EBIT may increase by 10%. Therefore, under two economic scenarios, we perform EBP – EBIT Analysis.
Further, it is assumed that company needs $100 million for a project that has to be financed either by equity or debt. In the financial year 2015, company paid interest of $18.8 million over the debt of $330.77 million (financial report, 2016). Thus, the current interest rate is 5.6%.
It is assumed that the additional raising of debt may attract the interest rate of 0.75%.
Again, the current market price of stock is $91.67
The number of outstanding equity is 151 million.
Company is financial strong but it has to face stiff competition with its rivals. Further, company needs to expand its business over other geographical area. Product line is also need to be expanded. Therefore, it would be better to raise the fund from the market rather than using the internal fund.
Under different scenario, the EPS – EBIT result is as follows:
100% Debt financing
100% Equity financing
Common Stock FinancingRecession / Normal / Boom
EBIT / $12,936,000 / $16,170,000 / $19,404,000
Interest / 0 / 0 / 0
EBT / 12,936,000 / 16,170,000 / 19,404,000
Taxes / 4,466,801 / 5,583,501 / 6,700,201
EAT / 8,469,199 / 10,586,499 / 12,703,799
# Shares / 152,090,869 / 152,090,869 / 152,090,869
EPS / 0.06 / 0.07 / 0.08
50% debt and 50% equity
25% debt - 75% equity and 75% debt – 25% equity
10% debt – 90% equity and 90% debt and 10% equity
From the above table it is clear that at 100% equity financing, the EPS is maximum under all the three scenario of recession, normal and boom.
Conclusion
The EPS – EBIT analysis suggests 100% equity financing. However, capital investment is costly and time-consuming but it would better in one sense that the debt-equity ratio in 0.1653 which is almost double of the debt-equity ratio in 2014 and 2013. Therefore, further equity addition would help to lower this rate, and company’s capital structure would be more stable. EPS – EBIT analysis doesn’t consider the other economic factors and business environments,in which the company is operating, so a further in-depth analysis is needed. However, as per the current scenario and company’s SWOT analysis, it is recommended to finance the additional capital through equity only.
References:
Steve (2003). Selecting sources of finance for business. Online available at:
Trisha (2006). EBIT – EPS Analysis in leverage: Concepts, Advantages and Other details.
Information retrieved from:
Ju, Parrino, PoteshmanWeisbach (2005). Horses and Rabbits? Trade-off theory and Optimal
capital structure. Journal of finance and quantitative analysis. Vol 40. No 2. Online available at:
VIjaykumarPrabhakaran (2013). Impact on Earnings per share (EPS) – A study with special
reference to Ucal Polymer Industries limited. Global Journal of Commerce & Management Perspective. VOl 2. Page No – 48-50. Online available at:
Financial report (2016). Information retrieved from: