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

Adding debt to the capital structure increases the financial leverage, which results in a higher return on equity (ROE) and thus higher earnings per share (EPS) for shareholders, as long as the actual EBIT is greater than the break-even level.

Which One of the Following Statements Is Correct Concerning the Relationship