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Unformatted text preview: ) as the firm increased
the proportion of debt in its capital structure, a strategy involving maximizing
EPS would also maximize owner wealth. But because risk premiums increase
with increases in financial leverage, the maximization of EPS does not ensure
owner wealth maximization. To select the best capital structure, both return
(EPS) and risk (via the required return, ks) must be integrated into a valuation
framework consistent with the capital structure theory presented earlier. Review Question
12–13 Explain the EBIT–EPS approach to capital structure. Include in your
explanation a graph indicating the financial breakeven point; label the
axes. Is this approach consistent with maximization of the owners’ wealth? 23. The degree of financial leverage (DFL) is reflected in the slope of the EBIT–EPS function. The steeper the slope,
the greater the degree of financial leverage, because the change in EPS (y axis) that results from a given change in
EBIT (x axis) increases with increasing slope and decreases with decreasing slope. CHAPTER 12 LG6 Leverage and Capital Structure 539 12.4 Choosing the Optimal Capital Structure
A wealth maximizatio...
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