Alternative Definition of Financial Leverage (Table) Homework Help

EPS at Various EBIT Levels

TABLE

Thus, the quotient is 1. Its implication is that 1 per cent change in EBIT will result in 1 per cent change in EPS, that is, proportionate. There is, therefore, no magnification in the EPS.

Like operating leverage, higher levels of risks are attached to higher degrees of financial leverage also. High fixed financial costs increase the financial leverage and, thus, financial risk. the financial risk refers to the risk of the firm not being able to cover its fixed financial costs. With the increase in financial charges, the firm is also required to raise the level of EBIT necessary to meet financial charges. If the firm cannot cover these financial payments, it can be technically forced into liquidation. Therefore, the very existence of the business is at stake. Obviously, the financial manager should take into consideration all such factors while formulating the firm's financing plan in terms of the mix of various sources of long-term funds, viz long-term debts, preference shares, equity funds including retained earnings. One of the objectives of planning an appropriate capital structure is to provide a high income for the equity owners, that is, to increase the EPS. To devise an appropriate capital structure or financing plan, the amount of EBIT under various financing plans should tie related to EPS. Thus, one widely used means of examining the effect of leverage is to analyse the relationship between EBIT and EPS..

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