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    Capital strucutre/EPS and Optimal debt ratio

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    12.19 Various capital structures Charter Enterprises currently has $1 million in total
    assets and is totally equity-financed. It is contemplating a change in its capital structure.
    Compute the amount of debt and equity that would be outstanding if the firm
    were to shift to each of the following debt ratios: 10%, 20%, 30%, 40%, 50%,
    60%, and 90%. (Note: The amount of total assets would not change.) Is there a
    limit to the debt ratio's value?

    12.21 EPS and optimal debt ratio Williams Glassware has estimated, at various debt
    ratios, the expected earnings per share and the standard deviation of the earnings
    per share as shown in the following table.

    Debt ratio Earnings per share (EPS) Standard deviation of EPS
    0% $2.30 $1.15
    20 3.00 1.80
    40 3.50 2.80
    60 3.95 3.95
    80 3.80 5.53

    a. Estimate the optimal debt ratio on the basis of the relationship between earnings
    per share and the debt ratio. You will probably find it helpful to graph the
    relationship.

    b. Graph the relationship between the coefficient of variation and the debt ratio.
    Label the areas associated with business risk and financial risk.

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    Solution Summary

    The solution explains two questions - finding limit to debt ratio in a capital structure and EPS and optimal debt ratio

    $2.19