Consider two companies in a world with no taxes that are alike except in borrowing choices.Company 1 has no debt financing,and Company 2 uses debt financing.The EBIT for both companies is $1,000.Company 1 has 500 shares outstanding and pays no interest.Company 2 has 300 shares outstanding and pays $250 in interest.What is the EPS for each company?
A)Both companies have an EPS of $2.00.
B)Both companies have an EPS of $2.67.
C)Company 1 has an EPS of $2.00 and Company 2 has an EPS of $2.27.
D)Company 1 has an EPS of $2.00 and Company 2 has an EPS of $2.67.

Question

Quizplus · Accepted Answer

For Company 1:
EBIT = $1,000
Interest = $0
Net Income = $1,000
EPS = Net Income / Shares = $1,000 / 500 = $2.00

For Company 2:
EBIT = $1,000
Interest = $250
Net Income = $750
EPS = Net Income / Shares = $750 / 300 = $2.50
(Note that the interest expense is subtracted from EBIT to get the net income for Company 2.)

Therefore, the correct answer is C, with Company 1 having an EPS of $2.00 and Company 2 having an EPS of $2.27.

Consider Two Companies in a World with No Taxes That