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CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Leverages

A company has a degree of operating leverage (DOL) of 3 and a degree of financial leverage (DFL) of 2. If sales increase by 5%, by what percentage will earnings per share (EPS) increase, assuming no change in preference dividends and tax rate?

EPS will rise by 30%. Combined leverage equals operating leverage multiplied by financial leverage, which is 3 x 2 = 6. A 5% increase in sales is therefore magnified six times, giving a 30% increase in earnings per share.

  1. A15%
  2. B10%
  3. C30%Correct
  4. D25%

Explanation

Degree of combined leverage = DOL x DFL = 3 x 2 = 6. Percentage change in EPS = 6 x 5% = 30%. Option 15% uses only DOL, and 10% uses only DFL, so each ignores one of the two leverage effects.

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