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14. A firm that is evaluating two capital structures using EBIT/EPS analysis finds that it generally generates an EBIT much greater than the EPS indifference point. If the firm expects that its EBIT will not fall below the EPS indifference point in the future, then it

a. should choose the capital structure with the higher amount of debt, because the leverage associated with the capital structure will generate higher EPS.

b. should choose the capital structure with the lower amount of debt, because there will be less leverage and thus higher EPS.

c. can choose either capital structure, because they both would have about the same leverage and thus the same EPS.

d. should not issue any debt—that is, have an all-equity capital structure—if it wants to maximize its EPS.

e. There is not enough information to answer this question.

Financial leverage that is produced by the fixed costs of debt magnifies returns (both positive and negative). If the firm is operating well above its financial breakeven point, then debt provides a good magnification; but the opposite is also true. Because this firm is operating well above the EPS indifference point, it can handle greater amounts of debt than a firm that operates closer to the indifference point. Stated differently, everything else equal, the greater the EBIT a firms generates, the greater the debt it can handle and the more advantageous it is to carry more debt.

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