EBIT-EPS Analysis
Basics of EBIT-EPS Approach
It is important to understand what EBIT and EPS
mean to understand what the analysis is meant to
be.
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EBIT refers to earnings before interest and
tax. The metric makes interest and taxes
irrelevant. Therefore, an investor can
understand how the company is performing out
of the balance sheet’s composition which
essentially makes interest and taxes the focal
point of consideration. In terms of EBIT, there is
no difference if a company has huge debt or no
debt at all. The repercussions will be the same.
EPS or earnings per share is the metric that
shows a company’s earnings including interests
and taxes. It is an important metric because it
shows the earnings on a per-share basis which
helps the investors understand how a company
performs on an overall basis. If a company’s
overall profit soars high but the payment to
investors is low, it is a bad gesture for investors
owning a fixed number of shares. EPS shows this
dynamic rule simply and in a clear manner.
The ratio between these two metrics can show how
the bottomline results, the company’s EPS, are
related to its performance irrespective of its capital
structure, the EBIT.
Option A: Issuing $1,000,000 of 8% bonds
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Interest expense on bonds = 8% x $1,000,000 =
$80,000
Earnings before taxes (EBT) = EBIT - interest
expense = $500,000 - $80,000 = $420,000
Taxes (at 40% tax rate) = 0.4 x $420,000 =
$168,000
Net income available to common shareholders =
EBT - taxes = $420,000 - $168,000 = $252,000
Earnings per share (EPS) = Net income available
to common shareholders / number of common
shares outstanding Assuming 100,000 shares of
common stock outstanding: EPS = $252,000 /
100,000 = $2.52 per share
Option B: Issuing $500,000 of 10% preferred stock
and $500,000 of common stock

Preferred stock dividend = 10% x $500,000 =
$50,000
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Net income available to common shareholders =
EBIT - preferred dividends
Net income available to common shareholders =
$500,000 - $50,000 = $450,000
Taxes (at 40% tax rate) = 0.4 x $450,000 =
$180,000
Net income available to common shareholders
after taxes = $450,000 - $180,000 = $270,000
Earnings per share (EPS) = Net income available
to common shareholders after taxes / number of
common shares outstanding Assuming 100,000
shares of common stock outstanding: EPS =
$270,000 / 100,000 = $2.70 per share
Various advantages derived from EBIT‐EPS analysis
may be enumerated below:
Financial Planning: Use of EBIT‐EPS analysis is
indispensable for determining sources of funds. In
case of financial planning the objective of the firm
lies in maximizing EPS. EBIT‐ EPS analysis
evaluates the alternatives and finds the level of EBIT
that maximizes EPS.
Comparative Analysis: EBIT‐EPS analysis is useful
in evaluating the relative efficiency of departments,
product lines and markets. It identifies the EBIT
earned by these different departments, product lines
and from various markets, which helps financial
planners rank them according to profitability and
also assess the risk associated with each.
Performance Evaluation: This analysis is useful in
comparative evaluation of performances of various
sources of funds. It evaluates whether a fund
obtained from a source is used in a project that
produces a rate of return higher than its cost.
Determining Optimum Mix: EBIT‐EPS analysis is
advantageous in selecting the optimum mix of debt
and equity. By emphasizing on the relative value of
EPS, this analysis determines the optimum mix of
debt and equity in the capital structure. It helps
determine the alternative that gives the highest value
of EPS as the most profitable financing plan or the
most profitable level of EBIT as the case may be.
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