Point of Indifference

The point of indifference is the level of EBIT (earnings before interest and taxes) at which two different financing alternatives have the same EPS (earnings per share). In other words, it is the level of EBIT at which a company is indifferent between two financing alternatives.

For example, consider a company that is considering financing a new project with either debt or equity. The cost of debt is lower than the cost of equity, but using too much debt can increase the company’s financial risk. The point of indifference is the level of EBIT at which the EPS is the same, regardless of whether the project is financed with debt or equity.

By calculating the point of indifference, the company can determine the EBIT level at which both financing alternatives have the same financial outcome. If the expected EBIT level is higher than the point of indifference, the company should finance the project with debt, while if the expected EBIT level is lower than the point of indifference, the company should finance the project with equity.

The point of indifference is a useful tool for evaluating financing alternatives and determining the optimal mix of debt and equity financing for a project. It helps companies make informed decisions about their financing choices, based on their expected EBIT levels and financial risk tolerance.