A company needs total funds of Rs. 40 lakh and expects an EBIT of Rs. 6 lakh. It is comparing two plans:
Plan P: the whole amount is raised through 4,00,000 equity shares of Rs. 10 each.
Plan Q: Rs. 20 lakh is raised through 2,00,000 equity shares of Rs. 10 each and Rs. 20 lakh through debt at 10% p.a.
The tax rate is 40%. How does the earnings per share (EPS) under Plan Q compare with that under Plan P?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → It is higher by Rs. 0.30
Given:
EBIT = Rs. 6 lakh
Tax rate = 40%
Plan P: 4,00,000 shares, no debt
Plan Q: 2,00,000 shares, debt Rs. 20 lakh at 10% p.a.
Formula: EPS = (EBIT − Interest) × (1 − tax rate) / Number of equity shares
Plan P: EBT = 6 − 0 = Rs. 6 lakh
Plan P: tax = 40% of 6 = Rs. 2.4 lakh
Plan P: EAT = 6 − 2.4 = Rs. 3.6 lakh
Plan P: EPS = 3,60,000 / 4,00,000 = Rs. 0.90
Plan Q: interest = 10% of 20 = Rs. 2 lakh
Plan Q: EBT = 6 − 2 = Rs. 4 lakh
Plan Q: tax = 40% of 4 = Rs. 1.6 lakh
Plan Q: EAT = 4 − 1.6 = Rs. 2.4 lakh
Plan Q: EPS = 2,40,000 / 2,00,000 = Rs. 1.20
Result: 1.20 − 0.90 = Rs. 0.30 higher under Plan Q.
The RoI of 6 / 40 = 15% is above the 10% interest, so debt raises EPS.
Option (1) It is higher by Rs. 0.50 — Incorrect. This leaves out tax: 4 / 2 = 2.00 and 6 / 4 = 1.50.
Option (2) It is lower by Rs. 0.30 — Incorrect. The size is right but the direction is wrong. Plan Q's EPS is higher.
Option (3) It is higher by Rs. 0.90 — Incorrect. This leaves out Plan Q's interest: 6 × 0.6 / 2 = 1.80, less 0.90.
Option (4) It is higher by Rs. 0.30 — Correct. As worked out above.
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. …”
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