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CMA Intermediate · Financial Management and Business Data Analytics · Leverage Analyses and EBIT - EPS Analysis

A firm's DOL is 1.8 at its current sales level. Which statement about its DCL is correct if the company has no debt and no preference shares?

An all-equity firm has no interest, so DFL equals 1. DCL is then DOL multiplied by 1, which is 1.8. Tax rate is irrelevant to this calculation.

  1. ADCL is 1.8, because DFL equals 1Correct
  2. BDCL is zero, because there is no financial risk
  3. CDCL is 3.6, because DFL is 2 for all-equity firms
  4. DDCL cannot be computed without the tax rate

Explanation

With no interest and no preference dividend, EBT equals EBIT, so DFL = 1. DCL = DOL x DFL = 1.8 x 1 = 1.8. The tax rate does not affect leverage measured on pre-tax earnings.

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