Question

Abrams Steel Company has very high operating leverage due to the capital intensive nature of the steel business. Abrams' CEO is concerned about the variability in the firm's EPS if sales should drop, and decides to take action. Which of the following will reduce the variability in the firm's EPS for a given change in sales?

a. The CEO may increase the firm's financial leverage and hence reduce the variability by using non-shareholder money to support the business.

b. The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.

c. The CEO may increase the firm's total leverage by raising money from the sale of common stock.

d. The CEO may issue more corporate bonds and use the proceeds to pay off short-term liabilities.

Answer 1

The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.

Step-by-step explanation:

Earnings per share is defined as the amount that is earned per unit of a companie's share in a particular period.

When there is variability in EPS of a company investors tend to lose confidence in performance of the company.

This is because positive performance in one period may not be sustained in the next period.

In order to reduce variability the CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.

Leverage is the use of debt to buy more assets. Reducing high leverage of the company will reduce the amount the company is obligated to pay other parties. So earning are not affected by debt repayment.

This will reduce variability in EPS.