A second observation is that debt financing reduces earnings after tax, an apparent disadvantage to debt. However, it is important to realize that this is only half the story, for although debt financing does reduce earnings after tax, it also reduces shareholders’ investment in the firm. And personally, I would rather earn $90 on a $500 investment than $100 on a $1,000 investment. To capture both effects, it is useful to look at earnings per share and return on equity, two widely tracked indicators of equity performance. First, examining the boom conditions in Table 6.6 we see the expected effect of leverage on shareholder performance: EPS with debt financing is 15 percent higher than with equity, while ROE is a robust 31 percent higher. Under bust conditions, however, the reverse is true: Stock financing in difficult times produces a higher EPS and ROE
than debt. This corresponds to our earlier example when the return on invested capital (ROIC) was less than the after-tax interest rate.
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