If a company increases its financial leverage, how is the impact on Earnings Per Share (EPS)?a.EPS decreasesb.No impact on EPSc.EPS increasesd.EPS becomes negativeCLEAR MY CHOICE
Question
If a company increases its financial leverage, how is the impact on Earnings Per Share (EPS)?a.EPS decreasesb.No impact on EPSc.EPS increasesd.EPS becomes negativeCLEAR MY CHOICE
Solution
Financial leverage is the use of debt to buy more assets. When a company increases its financial leverage, it is essentially borrowing money to invest in more assets with the expectation that the income from the new investment will exceed the cost of borrowing.
Earnings Per Share (EPS) is calculated as the net income of the company divided by the number of outstanding shares.
If a company increases its financial leverage, it is taking on more debt. If the investments made with this debt generate a return higher than the cost of the debt, then the net income of the company will increase. This, in turn, will increase the EPS, assuming the number of shares remains constant.
However, if the return on the investments is less than the cost of the debt, the net income will decrease, leading to a decrease in EPS.
So, the impact on EPS when a company increases its financial leverage can be either an increase or a decrease, depending on whether the return on the new investments is greater or less than the cost of the debt.
Therefore, none of the options provided (a. EPS decreases, b. No impact on EPS, c. EPS increases, d. EPS becomes negative) is universally correct. The impact on EPS depends on the specific circumstances.
Similar Questions
Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings (EBI)?Multiple select question.Financial leverage increases the slope of the EPS line.The rate of return on assets is unaffected by leverage.Below the indifference or break-even point in EBIT, an unlevered capital structure is best.Above the indifference or break-even point in EBIT, the increase in EPS for all equity structures is greater than leveraged structures.
If Additional financial leverage is always accompanied byadditional financial risk, then if the operating income that is expected toincrease actually decreases, shareholder experience a _______ of earnings pershare (EPS) and the rate of return becomes ______. Fill in the blanks.1 pointmagnification; volatilemagnification; steadydemagnification; steadydemagnification; volatile
11. Many commentators believe that the trend of earnings per share (EPS) is a more reliable indicator of underlying performance than the trend of the net profit for the year. Which of the following statements supports this view? A Net profit can be manipulated by the choice of accounting policies but EPS cannot be manipulated in this way. B EPS takes into account the additional resources made available to earn profit when new shares are issued for cash, whereas net profit does not. C The disclosure of a diluted EPS figure is a forecast of the trend of profit for future periods. D The comparative EPS is restated where a change in accounting policy affects the previous year’s profits. 12. Which TWO of the following statements about IAS 20 Accounting for Government Grants and Disclosure of Government Assistance are true? A A government grant related to the purchase of an asset must be deducted from the carrying amount of the asset in the statement of financial position. B A government grant related to the purchase of an asset should be recognised in profit or loss over the life of the asset. C Free marketing advice provided by a government department is excluded from the definition of government grants. D Any required repayment of a government grant received in an earlier reporting period is treated as prior period adjustment
Financial leverage affects the performance of a firm because the range of possible values for Blank______.Multiple choice question.earnings per share is smalleroperating income is widerearnings per share is wideroperating income is smaller
ABC Corporation has a net income of $1,000,000 and incurs interest expenses of $200,000 on its debt. The company has 200,000 shares outstanding. What is the impact on Earnings Per Share (EPS) after deducting interest expenses?a.$4.00b.$5.00c.$3.75d.$4.25
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.