The required return associated with a given level of

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Unformatted text preview: eturn associated with a given level of financial risk can be estimated in a number of ways. Theoretically, the preferred approach would be first to estimate the beta associated with each alternative capital structure and then to use the CAPM framework presented in Equation 5.7 to calculate the required return, ks. A more operational approach involves linking the financial risk associ- CHAPTER 11 449 Leverage and Capital Structure ated with each capital structure alternative directly to the required return. Such an approach is similar to the CAPM-type approach demonstrated in Chapter 9 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 Expanding the JSG Company example presented earlier, we assume that the firm is attempting to choose the best of seven alternative capital structures—debt ratios of 0%, 10%, 20%, 30%, 40%, 50%, and 60%. For each of thes...
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This document was uploaded on 03/30/2014.

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