When Assessing the Impact of Leverage on Capital Structure Decisions

question 23

Multiple Choice

When assessing the impact of leverage on capital structure decisions, a company can determine how much confidence it has in its choice of financial options by using the EBIT-EPS indifference chart. How is an EBIT-EPS indifference chart used?

• A) By calculating the slope of the line at the indifference point.
• B) By observing the position of the indifference point relative to EPS.
• C) By calculating the slope of the line of the chosen financial option.
• D) By observing the size of the margin of safety triangle that appears between and below the lines formed by the financial options.
• E) By determining the distance between the indifference point and the expected level of earnings before interest and taxes.

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Definitions:

Maturity Risk Premiums

Additional returns required by investors for holding longer-term securities, compensating for the increased risk of price fluctuations and changes in interest rates over time.

Upward Sloping

A graph line that shows an increase in value over time, often used in economics and finance to indicate growth.

Convertible Bonds

Security that is convertible into shares of common stock, at a fixed price, at the option of the bondholder.

Subordinated Debt

A type of debt that ranks below other debts with regard to claims on assets or earnings in the event of a liquidation.