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of variation of EPS for alternative capital structures for
Cooke Company Expected EPS ($) FIGURE 12.4 3.50 Maximum EPS 3.18
0 10 20 30 40 50 60 Coefficient of Variation of EPS CHAPTER 12 Debt Ratio (%)
(a) Leverage and Capital Structure 531 1.50
0 10 20 30 40 50 60 70 80
Debt Ratio (%)
(b) expected EPS and coefficient of variation relative to the debt ratio. Plotting the
data from Table 12.13 results in Figure 12.4. The figure shows that as debt is
substituted for equity (as the debt ratio increases), the level of EPS rises and then
begins to fall (graph a). The graph demonstrates that the peak earnings per share
occurs at a debt ratio of 50%. The decline in earnings per share beyond that ratio
results from the fact that the significant increases in interest are not fully offset by
the reduction in the number of shares of common stock outstanding.
If we look at the risk behavior as measured by the coefficient of variation
(graph b), we can see that r...
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