In the EBIT-EPS approach to capital structure, risk is represented by ________.
A) the slope of the capital market line
B) shifts in the cost of debt capital
C) the slope of the capital structure line
D) shifts in the times-interest-earned ratio

Question

Quizplus · Accepted Answer

The EBIT-EPS approach involves determining the optimal capital structure that maximizes earnings per share (EPS) for a given level of earnings before interest and taxes (EBIT). In this approach, risk is represented by the slope of the capital structure line, which shows the change in EPS for a given change in EBIT. A steeper slope indicates higher financial risk since small changes in EBIT can lead to large changes in EPS. Therefore, the goal is to identify the capital structure that balances the benefits of borrowing (i.e., tax savings from interest payments) with the risks of financial distress.

In the EBIT-EPS Approach to Capital Structure, Risk Is Represented