Skip to content

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

A firm has a degree of operating leverage (DOL) of 3 and a degree of financial leverage (DFL) of 1.5 at its current level of sales. If sales increase by 8%, what is the expected percentage increase in earnings per share, assuming no change in the number of shares?

EPS is expected to rise by 36%. Combined leverage is operating leverage multiplied by financial leverage, which is 3 times 1.5, or 4.5. Multiplying this by the 8% rise in sales gives a 36% rise in earnings per share.

  1. A12%
  2. B24%Correct
  3. C36%
  4. D4.5%

Explanation

DCL = DOL x DFL = 3 x 1.5 = 4.5. EPS change = 4.5 x 8% = 36%. Check: EBIT rises 3 x 8 = 24%, and EPS rises 1.5 x 24 = 36%. The 24% option stops at the EBIT change and ignores financial leverage; 12% is 1.5 x 8, ignoring operating leverage; 4.5% is the DCL, not multiplied by 8%.

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