Question

creative industries Inc. is looking to finance a new project with either debt or equity. the firm anticipates that its breakeven EPS-EBIT point is when EBIT reaches $3,000,000. if the projected EBIT are $3,500,000 for the foreseeable future, then to maximize EPS the firm should issue______.
a. equity
b.debt
c.preferred shares
d. a dual class of equity

Answer 1

Solution :-

The right option is (b) debt

Explanation :-

Breakeven EBIT EPS point is when EBIT is $3,000,000 and it means that when EBIT is $3,000,000 then the EPS will be same for different alternative of capital structure .

So, when EBIT is projected to increase than the break even point , the company should use debt in its capital structure as it will increase financial leverage (fixed cost financing) as well as there is tax benefit of debt also which will maximize the EPS.

The firm should use debt to maximize EPS.