Financial Management: Core Concepts, Third Edition

16.3 Break-Even Earnings for Different Capital Structures

From the previous section, we see that the three capital structures have different earnings per share as we vary the EBIT. We can also solve for the EBIT that produces the same EPS for any two comparable firms. Finding this break-even EBIT will then determine at what level the company should consider using debt. Below the break-even amount, there is no benefit in debt financing. Above the break-even amount, the owners benefit from financial leverage. We will start with the all-equity firm, Company 1 (with no debt financing), and Company 2, with the 50/50 capital structure. We begin by writing down the EPS formula for each firm:

Table 16.3 Earnings per Share of Firms with Different Funding ...