In considering EBIT-EPS analysis, which of the following statements is (are) correct?
A) If the expected earnings are above the indifference point, the debt option is preferred.
B) If the expected earnings are below the indifference point, the equity option is preferred.
C) Both statements are correct.
D) Neither statement is correct.

Question

Quizplus · Accepted Answer

In EBIT-EPS analysis, the indifference point is the level of earnings before interest and taxes (EBIT) at which the earnings per share (EPS) is the same for two different financing options, such as debt and equity.

A) If the expected earnings are above the indifference point, the debt option is preferred.
B) If the expected earnings are below the indifference point, the equity option is preferred.
C) Both statements are correct.
D) Neither statement is correct.

B) If the expected earnings are below the indifference point, it means that the EBIT is lower than the level at which the EPS is the same for both options. Therefore, the equity option is preferred because it will result in higher EPS since there is no interest expense to be paid.

Thus, both statements are correct.

In Considering EBIT-EPS Analysis, Which of the Following Statements Is