Principles of Managerial Finance

530 PART 4 Long-Term Financial Decisions

TABLE 12.13 Expected EPS, Standard Deviation, and

Coefficient of Variation for Alternative

Capital Structures for Cooke Company

Coefficient of

Standard deviation variation of EPS

Capital structure Expected EPS of EPS [(2)(1)]

debt ratio (1) (2) (3)

0% $2.40 $1.70 0.71

10 2.55 1.88 0.74

20 2.72 2.13 0.78

30 2.91 2.42 0.83

40 3.12 2.83 0.91

50 3.18 3.39 1.07

60 3.03 4.24 1.40

–4 –3 –2 –1 0 1 2 3

2.403.03

456789

EPS ($)

Debt Ratio = 0%

Debt Ratio = 60%

Probability

Density

FIGURE 12.3

Probability Distributions
Probability distributions of EPS
for debt ratios of 0% and 60% for
Cooke Company

ability distribution of EPS associated with each of them. Figure 12.3 shows these

two distributions. The expected level of EPS increases with increasing financial

leverage, and so does risk, as reflected in the relative dispersion of each of the dis-

tributions. Clearly, the uncertainty of the expected EPS, as well as the chance of

experiencing negative EPS, is greater when higher degrees of financial leverage

are employed.

Further, the nature of the risk–return tradeoff associated with the seven cap-

ital structures under consideration can be clearly observed by plotting the