When comparing levered versus unlevered capital structures,leverage works to increase EPS for high levels of EBIT because interest payments on the debt
A)increase as EBIT increases.
B)stay fixed,leaving more income to be distributed over fewer shares.
C)stay fixed,leaving less income to be distributed over fewer shares.
D)stay fixed,leaving less income to be distributed over more shares.
E)decrease as EBIT increases.

Question

Quizplus · Accepted Answer

When a company uses leverage in its capital structure, it incurs interest expenses on the debt which reduce its net income. However, this reduction is proportional to the level of EBIT. In other words, as the level of EBIT increases, the interest payment does not increase at the same rate, leading to a higher net income and EPS. This happens because the interest payments are fixed, regardless of EBIT, and represent a smaller percentage of the total income at higher levels of EBIT. Therefore, choice B is the correct answer.

When Comparing Levered Versus Unlevered Capital Structures,leverage Works to Increase