Maryland Limited's capital structure consists of Rs 60 crore worth of equity capital(Rs 10). The firm's current EBIT is 86 crore and interest is 16 crore .

The firm requires Rs. 200 crore of external financing for which it is considering two alternatives:

Alternative A : Issue of 1.6 crore equity shares of Rs 10 par at Rs. 125 each.

Alternative B : Issue of Rs.200 crore of debentures carrying 8 percent interest rate.

Tax rate is 30%.

What is the EPS-EBIT indifference point?

What is the EPS at this point?

• The EPS-EBIT indifference point, EBIT = Rs. 92 Crore
• EPS at indifference Point = Rs. 7

Step-by-step explanation

1) At indifference point, EPS of Alternative 1 = EPS of Alternative 2

• EPS = (EBIT - Interest) * (1-tax rate) / Number of shares

At indifference point ,

((Indifference point of EBIT - Interest of Alternative 1 ) x (1-tax rate)) / Outstanding Share in Alternative 1 = ((Indifference point of EBIT - Interest of Alternative 2) x (1-tax rate))/Outstanding Share in Alternative 2

Where,

• Let assume Indifference point, EBIT = X
• Interest of Alternative 1 = Existing Interest cost of 16 crore
• Tax rate = 30%
• Outstanding Share in Alternative 1 = Existing Shares + new Shares = 60/10 + 1.6 = 7.6
• Interest of Alternative 2 = Existing Interest cost + New Interest cost = 16 crore + 200*8% = 32
• Outstanding Share in Alternative 2 = Existing Shares = 60/10 = 6

Putting above in equation,

((X - 16 ) x (1-30%)) /7.6 = ((X - 16 - 200*8%) x (1-30%))/6

Now Solving for X,

(X - 16 ) * 70%/7.6 = (X - 32) * 70% / 6

(X - 16) = (X - 32 ) * 70%/6 * 7.6/70%

(X - 16 ) = (X - 32 ) * 1.26666667

32 * 1.26666667 - 16 = X * 1.26666667 - X

0.26666667* X = 24.533333

X = 24.533333 / 0.26666667 = 92 crore

2) EPS at Indifference Point = (EBIT - Interest) * (1-tax rate) / Number of shares

Lets calculate at Alternative 1,

EPS = (92 - 16) * (1-30%) /7.6 = 7