## Trading on Equity and EBIT-EPS-MPS Relationship
### Trading on Equity
#### Definition
Trading on equity (also called financial leverage) refers to the use of fixed-cost funds (debt and preference shares) alongside equity to finance the business, with the aim of increasing returns to equity shareholders.
#### How It Works
- Company pays a fixed cost (interest on debt / preference dividend).
- If the company earns more than this fixed cost, the excess goes entirely to equity shareholders.
- This magnifies EPS upward.
#### The Double-Edged Sword
| ROI vs Fixed Cost | Effect on EPS | Leverage Type |
|---|---|---|
| ROI > Interest/Preference return | EPS increases ↑ | Favourable / Positive |
| ROI < Interest/Preference return | EPS decreases ↓ | Unfavourable / Negative |
| ROI = Interest/Preference return | No effect | Neutral |
> Caution: When business conditions deteriorate and ROI falls below the cost of debt, leverage works against shareholders — amplifying losses. Hence it is called a double-edged sword.
### EBIT → EPS → MPS Chain
Understanding how operating profit flows through to market value:
```
EBIT (Earnings Before Interest & Tax)
↓ [minus Interest]
EBT (Earnings Before Tax)
↓ [minus Tax]
EAT (Earnings After Tax = Net Profit)
↓ [minus Preference Dividend]
Earnings available to Equity Shareholders
↓ [÷ Number of equity shares]
EPS (Earnings Per Share)
↓ [× P/E ratio or investor sentiment]
MPS (Market Price Per Share)
```
#### Key Relationships
- Higher EBIT → Higher EPS (provided EBIT exceeds interest cost).
- Higher EPS → Higher MPS (generally, as investors value higher earnings per share).
- Debt boosts EPS when ROI > Cost of Debt — and depresses EPS when ROI < Cost of Debt.
- Low EBIT → Falls below Financial Break-Even Point → EPS turns negative.