The primary weakness of EBIT-EPS analysis is that
A) it ignores the implicit cost of debt financing.
B) it double counts the cost of debt financing.
C) it applies only to firms with large amounts of debt in their capital structure.
D) it may only be used by firms that are profitable this year.

Question

Quizplus · Accepted Answer

EBIT-EPS analysis is based solely on the impact of changes in EBIT on EPS and does not consider the impact of changes in capital structure or the implicit cost of debt financing. As a result, it assumes that the cost of debt financing is constant, regardless of the level of debt in the capital structure. However, the cost of debt financing generally increases as the level of debt increases, so this assumption may be invalid in practice. Therefore, the primary weakness of EBIT-EPS analysis is that it ignores the implicit cost of debt financing.

The Primary Weakness of EBIT-EPS Analysis Is That