A company has 2,00,000 equity shares and debt of Rs. 20 lakh at 10% p.a. The tax rate is 30%. Its EBIT rises from Rs. 5 lakh to Rs. 6 lakh. By what percentage does its earnings per share (EPS) rise?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → 33.33%
Given:
Equity shares = 2,00,000; Debt = Rs. 20 lakh at 10% p.a.
Tax rate = 30%; EBIT rises from Rs. 5 lakh to Rs. 6 lakh
EPS = Earnings after tax ÷ Number of equity shares
Interest = 10% of Rs. 20 lakh = Rs. 2 lakh
At EBIT of Rs. 5 lakh: EBT = 5 − 2 = Rs. 3 lakh
Tax = 30% of 3 = Rs. 0.90 lakh
EAT = 3 − 0.90 = Rs. 2.10 lakh
EPS = 2.10 lakh ÷ 2 lakh shares = Rs. 1.05
At EBIT of Rs. 6 lakh: EBT = 6 − 2 = Rs. 4 lakh
Tax = 30% of 4 = Rs. 1.20 lakh
EAT = 4 − 1.20 = Rs. 2.80 lakh
EPS = 2.80 lakh ÷ 2 lakh shares = Rs. 1.40
Rise in EPS = 1.40 − 1.05 = Rs. 0.35
Percentage rise = 0.35 ÷ 1.05 × 100 = 33.33%
Option (1) 20% — Incorrect. This is the rise in EBIT, 1 ÷ 5. Leaving out the interest gives the same: EPS goes from 1.75 to 2.10.
Option (2) 25% — Incorrect. Here the rise is divided by the new EPS: 0.35 ÷ 1.40.
Option (3) 35% — Incorrect. The rise of Rs. 0.35 per share is read as a per cent.
EPS rises faster than EBIT because the interest stays fixed at Rs. 2 lakh.
NCERT (2026-27 Edition): “EBIT-EPS Analysis … The impact of financial leverage on the profitability of a business can be seen through EBIT-EPS (Earning before Interest and Taxes-Earning per Share) analysis as in the following example. Three situations are considered. There is no debt in situation-I i.e. (unlevered business). Debt of Rs. 10 lakh and 20 lakh are assumed in situations-II and III, respectively. All debt is at 10% p.a. The company earns Rs. 0.93 per share if it is unlevered. With debt of Rs. 10 lakh its EPS is Rs. 1.05. With a still higher debt of Rs. 20 lakh, its, EPS rises to Rs. 1.40. Why is the EPS rising with higher debt? It is because the cost of debt is lower than the return that company is earning on funds employed. …” |