Which one of the following statements is correct concerning the relationship between a capital structure with debt and one without debt? Assume there are no taxes.
A) When a firm is operating at a point where the actual earnings before interest and taxes (EBIT) exceed the break-even level, then adding debt to the capital structure will increase the earnings per share (EPS).
B) The earnings per share will equal zero when EBIT is zero for a levered firm.
C) The advantages of leverage primarily occur when EBIT is just barely positive.
D) The firm's EPS will always be higher if the firm uses leverage.
E) EPS are more sensitive to changes in EBIT when a firm is unlevered.

Question

Quizplus · Accepted Answer

When a firm's EBIT exceeds the break-even level, adding debt (leverage) increases the EPS because the cost of debt is fixed, and additional earnings are distributed among the equity holders, enhancing their returns.

Which One of the Following Statements Is Correct Concerning the Relationship