 Earlier we see a capital fallacy that the leverage increases earning per share and therefore the market value per share should also be increased. Now this is an incorrect argument but it is given in the favour of leverage and we have recently seen that it is not necessary that the leverage may increase earnings per share rather the earnings per share may also go down. Now we see the relationship between EPS and the EBITING and how earnings per share is sensitive to a change in earnings before and in taxes interest and taxes. We have a graphic representation here where on the X axis we measure EBIT and on the Y axis we measure EPS or the earnings per share. We have two coloured lines here the red line shows the EPS with the leverage effect or the debt and the blue line shows EPS without debt. The break one point here is the EBIT of 6 million dollars for which we have earnings per share of point 6 dollars. Now we see that over 6 million earnings before interest and tax the EPS is much higher over the EPS without debt and this is due to the leverage effect whereas we see that below 6 million dollars of EBIT the earnings per share is lower with leverage and we also see that at the EBIT of 1.2 million dollars that is this is the amount of interest expense the earnings per share is negative below this point. So this graph says that as while rising with the leverage the risk of EPS also increases this shows that the line showing EPS with leverage is more steeper than the line showing EPS without leverage. Now to understand more this we have an example we assume that there is no growth in EBIT and there is no retention of earnings. This means that all of the earnings will be paid out as dividends. Now the requirement is that use MM 1 and 2 to show that increase in expected earnings per share will not increase the share price. Now we see that without leverage expected earnings per share is equal to 1 dollar and as a result the DPS or the dividend per share is also equal to 1 dollar because we have no retention plans so share price we see it is equal to 7.5 dollar. Now let us assume that the unlivered cost of capital without leverage is equal to 13.33 percent that we have computed using the values putting into the model. The first requirement is equity value as per MM proposition 1. We see that market value without that is equal to 75 million dollars which is the product of 100 million shares and 7.5 dollars each share being the market price per share and we have now share repurchase which is of 15 million dollars and that is the product of 20 million shares and the market value per share of 7.5 million dollars. So the remaining equity is the 60 million dollar of market value which is the product of remaining 8 million outstanding shares and the share market value of 7.5 dollars each. If we determine the price per share here with the effect of leverage under market proposition 2 then first we have to determine the cost of unlivered equity or RE which is equal to 14.66 or 14.67 percent using this cost of equity we can determine the price of the share which is equal to 57.5 dollars so 7.5 dollars per share and we see that before the effect of leverage we had the same share price and with the induction of the leverage we had the same share price so the higher EPS due to additional risk that effect has been cancelled due to the shareholders demand for higher returns so there is no change in the share market price and it is unaffected. The second fallacy of capital structure is the dilution of EPS which says that the new equity issue or the issuance of new shares will dilute the existing shareholders ownership and that is the fallacy too. The new shares will reduce the shares cash flows. The advocate of this argument says the same. In fact they say that the debt financing is correct or better option for the firm. Now this is a criticism on this argument that this argument ignores the effect that the issuance of debt will also bring cash into the firm so the so there is an inflow of the cash when the firm issues new equity shares. Now to understand this we have an example of JSA which is an we assume that it is an all equity firm with outstanding shares of 500 million with the share market value of 16 dollars each so the the firm is planning to have an investment of 1 billion dollars and that 1 billion dollar investment will be financed by the new equity issue of 1 billion dollars the same value so is there any change on the share price due to this new issue we see that the assets of the firm have market value of 8 billion dollars which is the product of 5 million shares and the 16 dollar market value of each share this means that the firm has to issue now 62.5 million new issue new shares to finance the investment cost of 1 billion dollars in order to collect 1 billion dollars. Now if we see the effect of this transaction we have a table here where we have no cash before the new issue but with the new issue we have a induction of cash by 1 billion dollars or 1,000 million dollars we have existing assets of 800 dollars and we have the same amount of existing dollars after the company goes for the new issue of equity we have total value of eight hundred eight thousand dollars eight thousand million dollars if the company does not issue any equity and if the company goes for the new issue we have 9,000 million dollars or the 9 billion dollars of market value of the total assets so if we compute share price per share then we have to determine the total number of shares we have 500 million shares in our earlier example where the company is not going for any issue that is the existing condition and with the issuance of new equity we have 562.5 million shares and we see that the share price we assume the same under both of the conditions so we see that the value per share is again the amount of 16 dollars each under the current condition and the condition in which the company is issuing new equity shares we see that the selling of new equity shares at the fair value is not giving any gain nor it is offering any loss to the existing shareholders because the cash received on this particular new issue offers dilution of the shares any gain or loss on such transaction will result from the NPV of the underlying investment and it is not the issuance of the funds that are responsible for creating any NPV or value for the firm