Principles of Managerial Finance

(Dana P.) #1

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

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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
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