The use of an eps maximizing approach generally

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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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