How to Calculate Degree of Financial Leverage with Joyful Tone
What is the firm's degree of financial leverage?
A firm has EBIT of $126 million and earnings before taxes (EBT) of $101 million. What is the firm's degree of financial leverage? (Round to the nearest hundredth: .00) A) DFL = $101 million / $126 million B) DFL = $101 million / $50 million C) DFL = $126 million / $101 million D) DFL = $126 million / $75 million
Answer:
The degree of financial leverage (DFL) is calculated by dividing the earnings before interest and taxes (EBIT) by the difference between EBIT and interest expenses. With an EBIT of $126 million and earnings before taxes (EBT) of $101 million, the DFL is $126 million / $101 million so the correct answer is option (C).
Explanation: The degree of financial leverage (DFL) is a ratio that measures the sensitivity of a company's earnings per share to fluctuations in its operating income, as a result of changes in its capital structure. The formula to calculate DFL is: DFL = EBIT / (EBIT - interest expenses)
In this case, the EBIT is $126 million and the earnings before taxes (EBT) are $101 million. Assuming that EBIT minus interest expenses equals EBT, we can calculate the firm's interest expenses as EBIT - EBT, which is $126 million - $101 million = $25 million. Therefore, the degree of financial leverage would be calculated as DFL = $126 million / ($126 million - $25 million) which simplifies to: DFL = $126 million / $101 million
Hence, the correct answer is C) DFL = $126 million / $101 million.