Question

Under what situation Earning per share of company falls with the increased use of debt?

Options

• When company's Return on Investment is equal to cost of debt.

• When company's Return on Investment is more than cost of debt.

• When company’s Return on Investment is less than cost of debt.

• More use of equity than debt.

Answer 1

When company’s Return on Investment is less than cost of debt.

Explanation:

• Earnings per Share (EPS) falls when Return on Investment (ROI) is less than the cost of debt because the company pays more interest than it earns on the funds borrowed.
• This reduces profitability and hence EPS.

If ROI is greater than the cost of debt, the company benefits from financial leverage, and EPS increases.