Impact of Financial Leverage on EPS

Very Hard Measures Of Leverage Financial Leverage

ABC Corp has a current capital structure with 40% equity and 60% debt. The company's Earnings Before Interest and Taxes (EBIT) is currently $2 million, and they are considering financing an expansion project that will increase EBIT by 25% but will also require additional debt of $1 million at an interest rate of 8%. Given this information, calculate the impact of additional financial leverage on the company's Earnings Per Share (EPS) and determine which of the following statements correctly reflects the expected change in EPS due to the new financing.

The EPS will increase because the additional EBIT from the project will more than compensate for the new interest expense.

The EPS will decrease because the increase in debt will raise the interest expense, negatively impacting net income.

The EPS will remain unchanged because the increase in EBIT and interest expense will offset each other.

Hint

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% Correct91%