Unformatted text preview: tal structure decision. It has obtained estimates of sales and the associated levels of earnings before interest and taxes (EBIT) from its forecasting group: There is a 25%
chance that sales will total $400,000, a 50% chance that sales will total $600,000,
and a 25% chance that sales will total $800,000. Fixed operating costs total
$200,000, and variable operating costs equal 50% of sales. These data are summarized, and the resulting EBIT calculated, in Table 12.9.
The table shows that there is a 25% chance that the EBIT will be $0, a 50%
chance that it will be $100,000, and a 25% chance that it will be $200,000.
When developing the firm’s capital structure, the financial manager must accept
as given these levels of EBIT and their associated probabilities. These EBIT data
effectively reflect a certain level of business risk that captures the firm’s operating
leverage, sales revenue variability, and cost predictability.
Financial Risk The firm’s capital structure directly affects i...
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