Question

2. In class, we discussed several ways that firms can secure financing for their strategies. Discuss the EBIT/EPS model. What are the advantages and disadvantages of each of the methods of securing funds?

Answer 1

EBIT stands for Earnings before tax and EPS stand for Earnings Per Share. The EBIT/EPS model is used to control the effect of various sources of funds on EPS. It helps to determine the ideal level of debt and equity in the capital structure.

Advantages of EBIT-EPS model

1) EBIT-EPS model allows maximise the earnings per share for any given value of earnings before interest and taxes. This model help us to select the best financial plan.

2) It gives comparative analysis which analysis the specific product, project, department and market.

3) The management of a company is able to know the capital structure which has been targeted to determine the target capital structure in order to maximise the EPS.

Disadvantages of EBIT-EPS model

1) The EBIT-EPS does not take into account the risk which is associated with the financing of the debt.

2) The higher complexity of the calculations in the more alternative financing plans.

3) It does not take into account the limitations of raising different sources of financing.