# Cooke Company’s current capital structure is as follows:

Cooke Company’s popular principal make is as follows:

Current principal make

Long-term score

$ 0

Common hoard equity (25,000 duty-outs at $20)

500,000

Total principal (assets)

$ 500,000

Let us affect that the strong is because seven choice principal makes. If we value these makes using the score harmony, they are associated after a while harmonys of 0, 10, 20, 30, 40, 50, and 60%. Assuming that (1) the strong has no popular liabilities, (2) its principal make popularly contains all equity as shown, and (3) the sum aggregate of principal scum constant16 at $500,000, the mix of score and equity associated after a while the seven score harmonys would be as shown in Consultation 12.10. Also

**TABLE 12.10**

Capital Structures Associated after a while

Alternative Score Ratios for Cooke

Company

Capital make ($000)

Debt harmony

(1)

Total effects^{a}

(2)

Debt

[(1) X (2)]

(3)

Equity

[(2) - (3)]

(4)

Shares of contemptible

hoard unappropriated (000)

[(4) ÷ $20]b

(5)

0%

$500

$0

$500

25

10

500

50

450

22.5

20

500

100

400

20

30

500

150

350

17.5

40

500

200

300

15

50

500

250

250

12.5

60

500

300

200

10

shown in the consultation is the compute of duty-outs of contemptible hoard unappropriated beneath each choice. Associated after a while each of the score smooths in shaft 3 of Consultation 12.10 would be an profit trounce that would be expected to acception after a while acceptions in financial leverage. The smooth of score, the associated profit trounce (productive to dedicate to all score), and the dollar aggregate of annual profit associated after a while each of the choice principal makes are summarized in Consultation 12.11. Because twain the smooth of score and the profit trounce acception after a while increasing financial leverage (score harmonys), the annual profit acceptions as polite. Consultation 12.12 uses the smooths of EBIT and associated probabilities familiar in Consultation 12.9, the compute of duty-outs of contemptible hoard rest in shaft 5 of Consultation 12.10, and the annual profit values conducive in shaft 3 of Consultation 12.11 to objurgate the rights per duty-out (EPS) for score harmonys of 0, 30, and 60%. A 40% tax trounce is affectd. Also shown are the resulting expected EPS, the type intermission of EPS, and the coefficient of diversity of EPS associated after a while each score harmony.17 Consultation 12.13 summarizes the connected certaintys for the seven choice principal makes. The values shown for 0, 30, and 60% score harmonys were familiar in Consultation 12.12, forasmuch-as calculations of alike values for the other score harmonys (10, 20, 40, and 50%) are not shown. Because the coefficient of diversity values the abandon referring-to to the expected EPS, it is the preferred abandon value for use in comparing principal makes. As the strong’s financial leverage acceptions, so does its coefficient of diversity of EPS. As expected, an increasing smooth of abandon is associated after a while acceptiond smooths of financial leverage. The referring-to abandons of the two extremes of the principal makes evaluated in Consultation 12.12 (score harmonys0% and 60%) can be illustrated by showing the prob

**TABLE 12.11**

Level of Debt, Profit Rate, and

Dollar Aggregate of Annual Interest

Associated after a while Cooke Company’s

Alternative Principal Structures

Capital make

score harmony

Debt ($000)

(1)

Interest trounce

on all score

(2)

Interest ($000)

[(1) X (2)]

(3)

0%

$0

0.00%

$0.00

10

50

9

4.5

20

100

9.5

9.5

30

150

10

15

40

200

11

22

50

250

13.5

33.75

60

300

16.5

49.5

**TABLE 12.9**

Sales and Associated EBIT

Calculations for Cooke

Company ($000)

Probability of sales

0.25

0.5

0.25

Sales revenue

$400

$600

$800

Less: Fixed liberal costs

200

200

200

Less: Variable liberal costs (50% of sales)

200

300

400

Earnings anteriorly profit and taxes (EBIT)

$0

$100

$200

ability arrangement of EPS associated after a while each of them. Symbol 12.3 shows these two arrangements. The expected smooth of EPS acceptions after a while increasing financial leverage, and so does abandon, as reflected in the referring-to arrangement of each of the arrangements. Clearly, the doubt of the expected EPS, as polite as the random of experiencing privative EPS, is greater when higher degrees of financial leverage are assiduous. Further, the disposition of the abandon–return tradeoff associated after a while the seven principal makes beneath inducement can be plainly observed by plotting the

**TABLE 12.13**

Expected EPS, Type Deviation, and

Coefficient of Diversity for Alternative

Capital Structures for Cooke Company

Capital make

score harmony

Expected EPS

(1)

Standard intermission

of EPS

(2)

Coefficient of

diversity of EPS

[(2) x (1)]

(3)

0%

$2.40

$1.70

0.71

10

2.55

1.88

0.74

20

2.72

2.13

0.78

30

2.91

2.42

0.83

40

3.12

2.83

0.91

50

3.18

3.39

1.07

60

3.03

4.24

1.4

expected EPS and coefficient of diversity referring-to to the score harmony. Plotting the certaintys from Consultation 12.13 results in Symbol 12.4. The symbol shows that as score is substituted for equity (as the score harmony acceptions), the smooth of EPS rises and then begins to descend (graph **a**). The graph demonstrates that the peak rights per duty-out occurs at a score harmony of 50%. The refuse in rights per duty-out further that harmony results from the certainty that the momentous acceptions in profit are not easily offset by the abatement in the compute of duty-outs of contemptible hoard unappropriated. If we appear at the abandon demeanor as valued by the coefficient of diversity (graph **b**), we can see that abandon acceptions after a while increasing leverage. A duty of the abandon can be attributed to affair abandon, but the duty that changes in exculpation to increasing financial leverage would be attributed to financial abandon.