Chapter 11 leverage and capital structure 431

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Unformatted text preview: umerical measure of the firm’s financial leverage. The degree of financial leverage (DFL) is the numerical measure of the firm’s financial leverage. Computing it is much like computing the degree of operating leverage. The following equation presents one approach for obtaining the DFL.7 DFL Percentage change in EPS Percentage change in EBIT (11.6) Whenever the percentage change in EPS resulting from a given percentage change in EBIT is greater than the percentage change in EBIT, financial leverage exists. This means that whenever DFL is greater than 1, there is financial leverage. EXAMPLE Applying Equation 11.6 to cases 1 and 2 in Table 11.6 yields Case 1: 100% 40% 2.5 Case 2: 100% 40% 2.5 In both cases, the quotient is greater than 1, so financial leverage exists. The higher this value, the greater the degree of financial leverage. A more direct formula for calculating the degree of financial leverage at a base level of EBIT is given by Equation 11.7, where the notation from Table 11.6 is used. Note that in the denominator, the term 1/(1 T) converts the after-tax preferred stock dividend to...
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This document was uploaded on 03/30/2014.

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