CONCEPT: Financial Management is concerned with optimal

procurement as well as usage of finance. For optimal procurement,

different available sources of finance are identified and compared in
terms of their costs and associated risks. It is related with obtaining of
funds, application of funds and disposal/ appropriation of surplus.

Role: Role of Financial Management cannot be over-emphasised, since

it has a direct bearing on the financial health of a business. The financial
statements such as Balance Sheet and Profit and Loss Account reflect a
firm’s financial position and its financial health. Almost all items in the
financial statements of a business are affected directly or indirectly
through some financial management decisions
(i) The size as well as the composition of Fixed Assets of the
business
(ii) The quantum of Current Assets as well as its break-up into
cash, inventories and receivables
(iii) The amount of long term and short -term financing to be used
(iv) Break-up of long- term financing into debt, equity etc
(v) All items in the Profit and Loss Account e.g., Interest, Expenses,
Depreciation etc. : Higher amount of debt means more interest
and less value of profit.
Thus, the overall financial health of a business is
determined by the quality of its financial management.
Good financial management aims at mobilisation of
financial resources at a lower cost and deployment of
these in most lucrative/attractive activities.

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 OBJECTIVES

Primary aim of financial management is to maximise shareholder’s

wealth, which is referred to as the wealth maximisation concept. It
means maximisation of the market value of equity shares. Market price
of equity share increase if the benefits from a decision exceed the cost
involved. Thus, all financial decisions aim at ensuring that each decision
is efficient and adds some value. Such value additions tend to increase
the market price of shares.
In fact, in all financial decisions, major or minor, the ultimate objective
that guides the decision-maker is that some value addition should take
place so that the market price of equity shares is maximised. It can
happen through efficient decision making. Decision-making is efficient if,
out of various available alternative the best is selected.
Shareholder’s wealth= Number of equity shares X Market value of a
share

FINANCIAL DECISIONS:
Financial decision-making is concerned with three broad decisions which
are as under:

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Investment Decision: A firm, therefore, has to choose where to
invest the resources, so that they are able to earn the highest possible
return for their investors. The investment decision, therefore, relates to
how the firm’s funds are invested in different assets.
Investment decision can be long term or short-term.
A long-term investment decision is also called a Capital Budgeting
decision. It involves committing the finance on a long-term basis. For
example, making investment in a new machine to replace an existing
one or acquiring a new fixed asset or opening a new branch etc. These
decisions are very crucial for any business since they affect its earning
capacity over the long run. The size of assets, the profitability, growth
and competitiveness are all affected by the capital budgeting decisions.
Short term investment decisions (also called working capital
decisions) are concerned with the decisions about the levels of cash,
inventories and debtors. These decisions affect the day to day working
of a business. These affect the liquidity as well as profitability of a
business. Efficient cash management, inventory management and
receivables management are essential ingredients of sound working
capital management

Factors affecting Capital Budgeting Decision:

(a) Cash flows of the project: When a company takes an investment
decision involving huge amount it expects to generate some cash flows
over a period. These cash flows are in the form of a series of cash
receipts and payments over the life of an investment. The amount of
these cash flows should be carefully analysed before considering a
capital budgeting decision.
(b) The rate of return: The most important criterion is the rate of return
of the project. These calculations are based on the expected returns

3
 from each proposal and the assessment of risk involved. Suppose,
there are two projects A and B (with the same risk involved) with a rate
of return of 10 per cent and 12 per cent, respectively, then under
normal circumstance, project B will be selected.
(c) The investment criteria involved: The decision to invest in a
particular project involves a number of calculations regarding the
amount of investment, interest rate, cash flows and rate of return.
There are different techniques to evaluate investment which are known
as capital budgeting techniques. These techniques are applied to each
proposal before selecting a particular project proposal.

Financing Decision:

This decision is about the quantum of finance to be raised from various

long-term sources. It involves identification of various available sources.
The main sources of funds for a firm are shareholder’s funds and
borrowed funds. A firm, therefore, needs to have a judicious mix of both
debt and equity in making financing decisions, which may be debt,
equity, preference share capital and retained earnings.

.
FINANCIAL RISK: Interest on borrowed funds have to be paid
regardless of whether or not a firm has made a profit. Likewise,
borrowed funds have to be repaid at a fixed time. The risk of default on
payment is known as financial risk.
The overall financial risk depends upon the proportion of debt in
the total capital.

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 Factors Affecting Financing Decision
1. Cost: The cost of raising funds through different sources are
different. A prudent financial manager would normally opt for a
source which is the cheapest.
2. Risk: The risk associated with different sources is different.
3. Floatation Costs: Higher the floatation cost, less attractive the
source.
4. Cash Flow Position of the Business: A stronger cash flow position
may make debt financing more viable than funding through equity.
5. Level of Fixed Operating Costs: If a business has high level of
fixed operating costs (e.g., building rent, Insurance premium,
Salaries etc.), It must opt for lower fixed financing costs. Hence,
lower debt financing is better. Similarly, if fixed operating cost is
less, more of debt financing may be preferred.
6. Control Considerations: Issues of more equity may lead to dilution
of management’s control over the business. Debt financing has no
such implication. Companies afraid of a takeover bid may
consequently prefer debt to equity.
7. State of Capital Markets: Health of the capital market may also
affect the choice of source of fund. During the period when stock
market is rising, more people are ready to invest in equity.
However, depressed capital market may make issue of equity
shares difficult for any company

Dividend Decision

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The third important decision that every financial manager has to take
relates to the distribution of dividend. Dividend is that portion of profit
which is distributed to shareholders. The decision involved here is how
much of the profit earned by company (after paying tax) is to be
distributed to the shareholders and how much of it should be retained in
the business for meeting the investment requirements.

Factors Affecting Dividend Decision:

1. Earnings: Dividends are paid out of current and past earning.
Therefore, earnings is a major determinant of the decision about
dividend.
2. Stability of Earnings: Other things remaining the same, a
company having stable earning is in a position to declare higher
dividends. As against this, a company having unstable earnings is
likely to pay smaller dividend.
3. Stability of Dividends: It has been found that the companies
generally follow a policy of stabilising dividend per share. The
increase in dividends is generally made when there is confidence
that their earning potential has gone up and not just the earnings
of the current year. In other words, dividend per share is not
altered if the change in earnings is small or seen to be temporary
in nature.
4. Growth Opportunities: Companies having good growth
opportunities retain more money out of their earnings so as to
finance the required investment. The dividend in growth
companies is, therefore, smaller, than that in the non– growth
companies.
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5. Cash Flow Position: Dividends involve an outflow of cash. A
company may be profitable but short on cash. Availability of
enough cash in the company is necessary for declaration of
dividend by it.
6. Shareholder Preference: While declaring dividends,
managements usually keep in mind the preferences of the
shareholders in this regard. If the shareholders in general desire
that at least a certain amount is paid as dividend, the companies
are likely to declare the same. There are always some
shareholders who depend upon a regular income from their
investments.
7. Taxation Policy: The choice between payment of dividends and
retaining the earnings is, to some extent, affected by difference in
the tax treatment of dividends and capital gains. If tax on dividend
is higher it would be better to pay less by way of dividends. As
compared to this, higher dividends may be declared if tax rates are
relatively lower. Though the dividends are free of tax in the
hands of shareholders a dividend distribution tax is levied
on companies. Thus, under the present tax policy, shareholders
are likely to prefer higher dividends.
8. Stock Market Reaction: Investors, in general, view an increase
in dividend as a good news and stock prices react positively to it.
Similarly, a decrease in dividend may have a negative impact on
the share prices in the stock market. Thus, the possible impact of
dividend policy on the equity share price is one of the important
factors considered by the management while taking a decision
about it.
9. Access to Capital Market: Large and reputed companies
generally have easy access to the capital market and therefore
may depend less on retained earnings to finance their growth.
These companies tend to pay higher dividends than the smaller
companies which have relatively low access to the market.
10. Legal Constraints: Certain provisions of the Company’s Act
place restrictions on pay outs as dividend. Such provisions must be
adhered to while declaring the dividends.
11. Contractual Constraints: While granting loans to a
company, sometimes the lender may impose certain restrictions on
the payment of dividends in future. The companies are required to

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ensure that the dividend does not violate the terms of the loan
agreement in this regard.

FINANCIAL PLANNING:

Financial planning is essentially preparation of a financial blueprint

of an organisation’s future operations. This process of estimating
the fund requirement of a business and specifying the sources of
funds is called financial planning. Financial planning takes into
consideration the growth, performance, investments and
requirement of funds for a given period.
Financial planning includes both short-term as well as long-term
planning. Long-term planning relates to long term growth and
investment. It focuses on capital expenditure programmes. Short-
term planning covers short-term financial plan called budget.
Financial planning usually begins with the preparation of a
sales forecast

Financial planning is not equivalent to or a substitute for financial

management. Financial management aims at choosing the best
investment and financing alternatives by focusing on their costs
and benefits. Its objective is to increase the shareholders wealth.
Financial planning on the other hand aims at smooth operations by
focusing on fund requirements and their availability in the light of
financial decisions.
TWIN OBJECTIVES OF FINANCIAL PLANNING:
financial planning strives to achieve the following twin objectives.
(a) To ensure availability of funds whenever these are
required: This include a proper estimation of the funds required
for different purposes such as for the purchase of long-term assets

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or to meet day to-day expenses of business etc. Apart from this,
there is a need to estimate the time at which these funds are to be
made available. Financial planning also tries to specify possible
sources of these funds.
(b) To see that the firm does not raise resources
unnecessarily: Excess funding is almost as bad as inadequate
funding. Even if there is some surplus money, good financial
planning would put it to the best possible use so that the financial
resources are not left idle and don’t unnecessarily add to the cost.

IMPORTANCE OF FINANCIAL PLANNING:

Financial planning is an important part of overall planning of any
business enterprise. It aims at enabling the company to tackle the
uncertainty in respect of the availability and timing of the funds
and helps in smooth functioning of an organisation. The
importance of financial planning can be explained as:
(i) It tries to forecast what may happen in future under
different business situations. By doing so, it helps the firms
to face the eventual situation in a better way. In other
words, it makes the firm better prepared to face the future.
The preparation of alternative financial plans to meet
different situations is clearly of immense help in running the
business smoothly.
(ii) It helps in avoiding business shocks and surprises and
helps the company in preparing for the future.
(iii) It helps in co-ordinating various business functions e.g.,
sales and production functions, by providing clear policies
and procedures.
(iv) Detailed plans of action prepared under financial planning
reduce waste, duplication of efforts, and gaps in
planning.
(v) It tries to link the present with the future. It provides a link
between investment and financing decisions on a continuous
basis.

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 (vi) By spelling out detailed objectives for various business
segments, it makes the evaluation of actual
performance easier.

CAPITAL STRUCTURE

Capital structure refers to the mix between owners and borrowed funds.
These shall be referred as equity and debt in the subsequent text. It can
be calculated as debt-equity ratio i.e., (Debt/ Equity)
or as the proportion of debt out of total capital i.e., (Debt /Debt +
Equity).
Capital structure of a business thus, affects both the
profitability and the financial risk.
A capital structure will be said to be optimal when the proportion of
debt and equity is such that it results in an increase in the value of the
equity share. In other words, all decisions relating to capital structure
should emphasis on increasing the shareholders’ wealth

DEBT IS CHEAPEST SOURCE OF FINANCE

Debt is considered the cheapest of all sources, tax deductibility of
interest makes it still cheaper. Cost of debt is lower than cost of equity
for a firm because lender’s risk is lower than equity shareholder’s risk,
since lenders earn on assured return and repayment of capital and,
therefore, they should require a lower rate of return.
Additionally, interest paid on debt is a deductible expense for
computation of tax liability whereas dividends are paid out of
after-tax profits. Increased use of debt, therefore, is likely to

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lower the overall cost of capital of the firm provided that cost of
equity remains unaffected.

DEBT IS CHEAPER BUT RISKY:

Debt is cheaper but is riskier for a business because payment of interest
and the return of principal is obligatory for the business. Any default in
meeting these commitments may force the business to go into
liquidation. There is no such compulsion in case of equity, which is
therefore, considered riskless for the business. Higher use of debt
increases the fixed financial charges of a business. As a result, increased
use of debt increases the financial risk of a business.

Factors affecting the Choice of Capital Structure

1. Cash Flow Position: Size of projected cash flows must be
considered before issuing debt. Cash flows must not only cover fixed
cash payment obligations but there must be sufficient buffer also for
meeting the debt service commitments i.e., payment of interest and
repayment of principal.
2. Interest Coverage Ratio (ICR): The interest coverage ratio refers
to the number of times earnings before interest and taxes of a company
covers the interest obligation. This may be calculated as follows:
ICR = EBIT/ Interest.
The higher the ratio, lower is the risk of company failing to meet its
interest payment obligations.
3. Debt Service Coverage Ratio (DSCR): Debt Service Coverage
Ratio takes care of the deficiencies referred to in the Interest Coverage
Ratio (ICR). It is calculated as follows:
Profit after tax+ depreciation + other non -cash expenses
Preference Dividend + Interest obligations

A higher DSCR indicates better ability to meet cash commitments and

consequently, the company’s potential to increase debt component in its
capital structure.
4. Return on Investment (RoI): If the RoI of the company is higher,
it can choose to use trading on equity to increase its EPS, i.e., its ability
to use debt is greater. RoI is an important determinant of the company’s

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 ability to use Trading on equity and thus the capital structure can
employ more debt.
5. Cost of debt: A firm’s ability to borrow at a lower rate increases its
capacity to employ higher debt. Thus, more debt can be used if debt can
be raised at a lower rate.
6. Tax Rate: Since interest is a deductible expense, cost of debt is
affected by the tax rate. The firms in our examples are borrowing @
10%. Since the tax rate is 30%, the after- tax cost of debt is only 7%. A
higher tax rate, thus, makes debt relatively cheaper and increases its
attraction vis-à-vis equity.
7. Cost of Equity: Stock owners expect a rate of return from the equity
which is related with the risk they are assuming. When a company
increases debt, the financial risk faced by the equity holders, increases.
Consequently, their desired rate of return may increase. It is for
this reason that a company cannot use debt beyond a point. If debt is
used beyond that point, cost of equity may go up sharply and share
price may decrease inspite of increased EPS. Consequently, for
maximisation of shareholders’ wealth, debt can be used only upto a
level.
8. Floatation Costs: Process of raising resources also involves some
cost. Public issue of shares and debentures requires considerable
expenditure. Getting a loan from a financial institution may not cost so
much. These considerations may also affect the choice between debt
and equity and hence the capital structure.
9. Risk Consideration: Use of debt increases the financial risk of a
business. Financial risk refers to a position when a company is unable to
meet its fixed financial charges namely interest payment, preference
dividend and repayment obligations. Apart from the financial risk, every
business has some operating risk (also called business risk). Business
risk depends upon fixed operating costs. Higher fixed operating costs
result in higher business risk and vice-versa. The total risk depends upon
both the business risk and the financial risk. If a firm’s business risk is
lower, its capacity to use debt is higher and vice-versa.
10. Flexibility: If a firm uses its debt potential to the full, it loses
flexibility to issue further debt. To maintain flexibility, it must maintain
some borrowing power to take care of unforeseen circumstances.
11. Control: Debt normally does not cause a dilution of control. A public
company issue of equity may reduce the managements holding in the

12
company and make it vulnerable to takeover. This factor also influences
the choice between debt and equity especially in companies in which the
current holding of management is on a lower side.
12. Regulatory Framework: Every company operates within a
regulatory framework provided by the law e.g., public issue of shares and
debentures have to be made under SEBI guidelines. Raising funds from
banks and other financial institutions require fulfilment of other norms.
The relative ease with which these norms can, be met or the procedures
completed may also have a bearing upon the choice of the source of
finance.
13. Stock Market Conditions: If the stock markets are bullish, equity
shares are more easily sold even at a higher price. Use of equity is often
preferred by companies in such a situation. However, during a bearish
phase, a company, may find raising of equity capital more difficult and it
may opt for debt. Thus, stock market conditions often affect the choice
between the two.

Management of Fixed Capital

Fixed capital refers to investment in long-term assets. Management of
fixed capital involves around allocation of firm’s capital to different
projects or assets with long-term implications for the business. These
decisions are called investment decisions or capital budgeting decisions
and affect the growth, profitability and risk of the business in the long
run.
It must be financed through long-term sources of capital such as equity
or preference shares, debentures, long-term loans and retained earnings
of the business. Fixed Assets should never be financed through short-
term sources
Investment in these assets would also include expenditure on
acquisition, expansion, modernisation and their replacement. launching a
new product line or investing in advanced techniques of production.
Major expenditures such as those on advertising campaign or research
and development programme having long term implications for the firm
are also examples of capital budgeting decisions.
The management of fixed capital or investment or capital
budgeting decisions are important for the following reasons:

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(i) Long-term growth and effects: These decisions have bearing on
the long-term growth. The funds invested in long-term assets are
likely to yield returns in the future. These affect future possibilities
and prospects of the business.
(ii) Large amount of funds involved: These decisions result in a
substantial portion of capital funds being blocked in long-term
projects. Therefore, these investment programmes are planned
after a detailed analysis is undertaken. This may involve decisions
like where to procure funds from and at what rate of interest.
(iii) Risk involved: Fixed capital involves investment of huge amounts.
It affects the returns of the firm as a whole in the long term.
Therefore, investment decisions involving fixed capital influence the
overall business risk complexion of the firm.
(iv) Irreversible decisions: These decisions once taken, are not
reversible without incurring heavy losses. Abandoning a project
after heavy investment is made is quite costly in terms of waste of
funds. Therefore, these decisions should be taken only after
carefully evaluating each detail or else the adverse financial
consequences may be very heavy.

Factors affecting the Requirement of Fixed Capital

1. Nature of Business: The type of business has a bearing upon the
fixed capital requirements. For example, a trading concern needs
lower investment in fixed assets compared with a manufacturing
organisation; since it does not require to purchase plant and
machinery etc.

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 2. Scale of Operations: A larger organisation operating at a higher
scale needs bigger plant, more space etc. and therefore, requires higher
investment in fixed assets when compared with the small organisation.
3. Choice of Technique: Some organisations are capital intensive
whereas others are labour intensive. A capital-intensive organisation
requires higher investment in plant and machinery as it relies less on
manual labour. The requirement of fixed capital for such organisations
would be higher. Labour intensive organisations on the other hand
require less investment in fixed assets. Hence, their fixed capital
requirement is lower.
4. Technology Upgradation: In certain industries, assets become
obsolete sooner. Consequently, their replacements become due faster.
Higher investment in fixed assets may, therefore, be required in such
cases. For example, computers become obsolete faster and are
replaced much sooner than say, furniture. Thus, such organisations
which use assets which are prone to obsolescence require higher fixed
capital to purchase such assets.
5. Growth Prospects: Higher growth of an organisation generally
requires higher investment in fixed assets. Even when such growth is
expected, a business may choose to create higher capacity in order to
meet the anticipated higher demand quicker. This entails higher
investment in fixed assets and consequently higher fixed capital.
6. Diversification: A firm may choose to diversify its operations for
various reasons, with diversification, fixed capital requirements increase
e.g., a textile company is diversifying and starting a cement
manufacturing plant. Obviously, its investment in fixed capital will
increase.
7. Financing Alternatives: A developed financial market may provide
leasing facilities as an alternative to outright purchase. When an asset is
taken on lease, the firm pays lease rentals and uses it. By doing so, it
avoids huge sums required to purchase it. Availability of leasing facilities,
thus, may reduce the funds required to be invested in fixed assets,
thereby reducing the fixed capital requirements. Such a strategy is
especially suitable in high risk lines of business.
8. Level of Collaboration: At times, certain business organisations
share each other’s facilities. For example, a bank may use another’s ATM
or some of them may jointly establish a particular facility. This is feasible
if the scale of operations of each one of them is not sufficient to make

15
full use of the facility. Such collaboration reduces the level of investment
in fixed assets for each one of the participating organisations.

FACTORS AFFECTING THE WORKING CAPITAL

REQUIREMENTS

1. Nature of Business: The basic nature of a business influences the

amount of working capital required. A trading organisation usually needs
a lower amount of working capital compared to a manufacturing
organisation. This is because there is, usually no processing, therefore,
there is no distinction between raw materials and finished goods. Sales
can be affected immediately upon the receipt of materials, sometimes
even before that. In a manufacturing business, however, raw material
needs to be converted into finished goods before any sales become
possible. Other factors remaining the same, trading business requires
less working capital. Similarly, service industries which usually do not
have to maintain inventory require less working capital.
2. Scale of Operations: For organisations which operate on a higher
scale of operation, the quantum of inventory, debtors required is
generally high. Such organisations, therefore, require large amount of
working capital as compared to the organisations which operate on a
lower scale.
3. Business Cycle: Different phases of business cycles affect the
requirement of working capital by a firm. In case of a boom, the sales as
well as production are likely to be higher and therefore, higher amount
of working capital is required. As against this the requirement for
working capital will be lower during period of depression as the sales as
well as production will be low.
4. Seasonal Factors: Most business have some seasonality in their
operations. In peak season, because of higher level of activity, higher
amount of working capital is required. As against this, the level of
activity as well as the requirement for working capital will be lower
during the lean season.
5. Production Cycle: Production cycle is the time span between the
receipt of raw material and their conversion into finished goods. Some
businesses have a longer production cycle while some have a shorter
one. Duration and the length of production cycle, affects the amount of
funds required for raw materials and expenses. Consequently, working

16
capital requirement is higher in firms with longer processing cycle and
lower in firms with shorter processing cycle.
6. Credit Allowed: Different firms allow different credit terms to their
customers. These depend upon the level of competition that a firm faces
as well as the credit worthiness of their clientele. A liberal credit policy
results in higher amounts of debtors, increasing the requirement of
working capital.
7. Credit Availed: Just as a firm allows credit to its customers it also
may get credit from its suppliers. To the extent, it avails the credit on its
purchases, the working capital requirement is reduced.
8. Operating Efficiency: Firms manage their operations with varied
degrees of efficiency. For example, a firm managing its raw materials
efficiently may be able to manage with a smaller balance. This is
reflected in a higher inventory turnover ratio. Similarly, a better debtor
turnover ratio may be achieved reducing the amount tied up in
receivable. Better sales effort may reduce the average time for which
finished goods inventory is held. Such efficiencies may reduce the level
of raw materials, finished goods and debtors resulting in lower
requirement of working capital.
9. Availability of Raw Material: If the raw materials and other
required materials are available freely and continuously, lower stock
levels may suffice. If, however, raw materials do not have a record of
un-interrupted availability, higher stock levels may be required. In
addition, the time lag between the placement of order and actual receipt
of the materials (also called lead time) is also relevant. Higher the lead
time, higher the quantity of material to be stored and higher is the
amount of working capital requirement.
10. Growth Prospects: If the growth potential of a concern is
perceived to be higher, it will require higher amount of working capital
so that is able to meet higher production and sales target whenever
required.
11. Level of Competition: Higher level of competitiveness may
necessitate higher stocks of finished goods to meet urgent orders from
customers. This increases the working capital requirement. Competition
may also force the firm to extend liberal credit terms discussed earlier.
12. Inflation: With rising prices, higher amounts are required even to
maintain a constant volume of production and sales. The working
capital requirement of a business thus, become higher with

17
higher rate of inflation. It must, however, be noted that an inflation
rate of 5%, does not mean that every component of working capital will
change by the same percentage. The actual requirement shall depend
upon the rates of price change of different components (e.g., raw
material, finished goods, labour cost,) Finished goods as well as their
proportion in the total requirement.

Concept of Trading on Equity:

The basic assumption relating to financial leverage is that the firm can
earn more on assets acquired by the borrowed funds. Since borrowed
funds require a fixed payment in the form of interest the difference
between the earnings from the assets and interest on the use of the
funds goes to the equity shareholders.

Hence use of fixed interest-bearing funds provide increased return on

equity investment without additional requirement of funds from the
shareholders. Trading on equity refers to the utilization of non-equity
sources of funds in the capital structure of an enterprise in consideration
to enhance earnings per share of the shareholders.

The use of borrowings for the purpose of financial advantage

for residual stockholders is called trading on equity.

In other words, trading on equity is a technique by which a firm tries to

maximize the return of equity shareholders by using fixed interest-
bearing securities in the capital structure. Trading on equity has direct
impact on shareholders’ wealth

Favourable financial leverage: return on investment > interest

on debt
Unfavourable financial leverage: return on investment<
interest on debt.

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Example of favourable financial leverage:
Suppose there are two situations for a company. In situation I it raises a
fund of Rs 5,00,000 through equity capital and in situation II, it raises the
same amount through two sources- Rs 2,00,000 through equity capital
and the remaining Rs3,00,000 through borrowings.

Also suppose the tax rate is 30% and the interest on borrowings is 10%.
The earnings per share (EPS) in the two situations is calculated as follows.

Situation I Situation II

Earnings before interest

1,00,000 1,00,000
and tax (EBIT)

Interest 30,000

Earnings Before Tax

1,00,000 70,000
(EBT)

Tax 30,000 21,000

Earnings After Tax (EAT) 70,000 79,000

No. Of equity shares 50,000 20,000

EPS= =1.4 =3.95

Clearly, in the second situation the EPS is greater than
in the first situation.

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