Skip to content

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

A company has EBIT of Rs 6,00,000, and interest of Rs 2,00,000. It has 10% preference share capital of Rs 4,00,000 and the tax rate is 25%. What is the degree of financial leverage, treating preference dividend as a fixed charge?

Degree of financial leverage with preference dividend equals EBIT divided by EBIT minus interest minus the tax-grossed preference dividend. Here this gives about 1.73, so none of the listed values is exact.

  1. A1.50
  2. B1.80Correct
  3. C1.33
  4. D2.40

Explanation

PBT = 6,00,000 - 2,00,000 = 4,00,000. Preference dividend = 40,000, pre-tax equivalent = 40,000/(1-0.25) = 53,333. DFL = EBIT/[EBIT - I - PD/(1-t)] = 6,00,000/(4,00,000 - 53,333) = 6,00,000/3,46,667 = 1.73. This does not match the options; the nearest intended computation is flawed, so the key is not reliable.

Did you get it right without looking?

One question tells you little. A timed set on Financing Decisions - Leverages shows your real accuracy, how long you take and where you lose marks.

Practise Financing Decisions - LeveragesFree diagnostic mock

More Financing Decisions - Leverages questions