#2 EBIT - EPS Analysis (Earning Per Share) - Financial Management ~ B.COM / BBA / CMA

Summary

This video script provides a detailed guide on calculating Earnings Per Share (EPS) in corporate finance. It outlines the process of assessing different financing options, starting with calculating EBIT, deducting interest, tax, and preference dividends, and then determining the earnings available to equity shareholders. The final step is to calculate EPS by dividing these earnings by the number of equity shares. The script emphasizes the importance of considering already issued equity shares and selecting the financing option that maximizes EPS, thus optimizing shareholder wealth.

Takeaways

• 😀 EBIT (Earnings Before Interest and Taxes) is the starting point for calculating EPS in all options.
• 😀 Interest on debentures is deducted from EBIT to calculate Earnings Before Tax (EBT).
• 😀 Tax is calculated on the EBT and subtracted to get the Earnings After Tax (EAT).
• 😀 Preference dividend is deducted based on the preference capital before calculating the earnings available to equity shareholders.
• 😀 Earnings available to equity shareholders is the remaining amount after all deductions (interest, tax, preference dividend).
• 😀 EPS (Earnings Per Share) is calculated by dividing the earnings available to equity shareholders by the number of equity shares.
• 😀 The option with the highest EPS is considered the best option for equity shareholders.
• 😀 Always consider the already issued equity shares when calculating EPS, not just the newly issued ones.
• 😀 The tax rate should be applied as per the rate specified in the exam or problem scenario.
• 😀 If debentures are present in a plan, interest is deducted accordingly, impacting the final EPS calculation.
• 😀 It’s important to correctly deduct the tax and preference dividends based on the amounts provided in the problem.

Q & A

What is the first step in calculating EPS for a given financial plan?

The first step is to start with EBIT (Earnings Before Interest and Taxes), which is the starting point for all options in the financial plan.

Why is interest deducted after calculating EBIT?

Interest is deducted because it represents the cost of borrowing, which reduces the overall earnings available for equity shareholders.

What does EBT stand for, and how is it calculated?

EBT stands for Earnings Before Tax. It is calculated by subtracting interest from EBIT.

How do you calculate the tax to be deducted from EBT?

Tax is calculated based on the EBT amount. For example, if the tax rate is 50%, you multiply the EBT by 50% to determine the tax deduction.

What is the role of preference dividends in the EPS calculation?

Preference dividends are deducted from earnings because they represent a fixed obligation to preference shareholders before the remaining earnings are available to equity shareholders.

How do you calculate the earnings available to equity shareholders?

The earnings available to equity shareholders are calculated by subtracting the interest, tax, and preference dividends from the EBIT. The remaining amount is what is available for equity holders.

What is the significance of the number of equity shares in the EPS calculation?

The number of equity shares is crucial because the earnings available to equity shareholders are divided by the number of shares to calculate EPS. This helps determine the wealth generated per share.

What mistake do some students make when calculating the number of equity shares?

Some students incorrectly assume that the number of equity shares is zero when there are debentures involved, neglecting the already issued equity shares in the calculation. This leads to incorrect results.

What should be done if the number of equity shares is not directly given in the problem?

If the number of equity shares is not given, you must account for both the already issued shares and any new shares in the financial plan to calculate EPS correctly.

How do you determine which financial plan is the best option based on EPS?

You compare the EPS of all the financial plans. The plan with the highest EPS is considered the best option because it maximizes earnings for the equity shareholders.