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Unformatted text preview: h each capital structure alternative directly to the required return. Such an
approach is similar to the CAPM-type approach demonstrated in Chapter 10 for
linking project risk and required return (RADR). Here it involves estimating the
required return associated with each level of financial risk, as measured by a statistic such as the coefficient of variation of EPS. Regardless of the approach used,
one would expect the required return to increase as the financial risk increases.
EXAMPLE Cooke Company, using as risk measures the coefficients of variation of EPS associated with each of the seven alternative capital structures, estimated the associated required returns. These are shown in Table 12.14. As expected, the estimated TABLE 12.14 Capital structure
0% Required Returns for Cooke
variation of EPS
(from column 3
of Table 12.13)
(1) Estimated required
(2) 0.71 11.5% 10 0.74 11.7 20 0.78 12.1 30 0.83 12.5 40 0.91 14.0 50 1.07 16.5 6...
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