7 where the notation from table 116 is used note that

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Unformatted text preview: a before-tax amount for consistency with the other terms in the equation. EBIT DFL at base level EBIT EBIT EXAMPLE I PD (11.7) 1 1 T Substituting EBIT $10,000, I $2,000, PD $2,400, and the tax rate (T 0.40) into Equation 11.7 yields the following result: $10,000 DFL at $10,000 EBIT $10,000 $2,000 $10,000 $4,000 $2,400 1 0.40 2.5 1 Note that the formula given in Equation 11.7 provides a more direct method for calculating the degree of financial leverage than the approach illustrated using Table 11.6 and Equation 11.6. 7. This approach is valid only when the same base level of EBIT is used to calculate and compare these values. In other words, the base level of EBIT must be held constant to compare the financial leverage associated with different levels of fixed financial costs. 432 PART 4 Long-Term Financial Decisions Total Leverage total leverage The potential use of fixed costs, both operating and financial, to magnify the effect of changes in sales on the firm’s earnings per share. EXAMPLE TABLE 11.7 We also can assess the combined effect of operating and financial leverage on the firm’s risk by using a framework similar to that used to dev...
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