Through the effects of financial leverage, when EBIT increases, earnings per share will
A) decrease.
B) remain unchanged.
C) increase.
D) change in an undetermined direction.

Question

Quizplus · Accepted Answer

Financial leverage refers to the use of debt to finance a company's operations. When a company uses debt financing, it incurs interest expenses on the debt. This interest expense is deducted from EBIT to arrive at net income, which is used to calculate earnings per share (EPS).

As EBIT increases, the amount of interest expense remains constant, which means that net income increases at a faster rate than EBIT. This results in an increase in EPS when a company uses financial leverage. Therefore, the correct choice is C - increase.

Through the Effects of Financial Leverage, When EBIT Increases, Earnings