CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Leverages
A company has DOL of 3 and DFL of 1.5. If sales are expected to rise by 8%, by what percentage will EPS rise, assuming no change in tax rate or number of shares?
EPS will rise by 36%. Degree of combined leverage is the product of operating and financial leverage, 3 × 1.5 = 4.5. Multiplying by the 8% rise in sales gives a 36% rise in EPS. Using only DOL would wrongly give 24%.
- A12%
- B24%Correct
- C36%
- D4.5%
Explanation
Combined leverage DCL = DOL × DFL = 3 × 1.5 = 4.5. Percentage change in EPS = 4.5 × 8% = 36%. The 24% option uses only DOL, ignoring financial leverage.
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