Unformatted text preview: 0 EBIT
$50 $225.00 The calculated value of the indifference point between the 0% and 30% capital structures is therefore $50,000, as
can be seen in Figure 12.6. 538 PART 4 Long-Term Financial Decisions Considering Risk in EBIT–EPS Analysis
When interpreting EBIT–EPS analysis, it is important to consider the risk of each
capital structure alternative. Graphically, the risk of each capital structure can be
viewed in light of two measures: (1) the financial breakeven point (EBIT-axis
intercept) and (2) the degree of financial leverage reflected in the slope of the capital structure line: The higher the financial breakeven point and the steeper the
slope of the capital structure line, the greater the financial risk.23
Further assessment of risk can be performed by using ratios. As financial
leverage (measured by the debt ratio) increases, we expect a corresponding
decline in the firm’s ability to make scheduled interest payments (measured by the
times interest earned ratio).
EXAMPLE Reviewing the three capital structures plotted for Cooke Company in Figure
12.6, we can see that as the debt ratio incre...
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