CS Professional · Strategic Management and Corporate Finance · Sources of Corporate Funding
A firm's Earnings Before Interest and Tax (EBIT) is Rs 6,00,000 and its interest expense on debt is Rs 2,00,000. What is its Degree of Financial Leverage (DFL)?
The Degree of Financial Leverage is 1.50. It equals EBIT divided by profit before tax, that is 6,00,000 divided by 4,00,000. A 1% change in EBIT therefore changes earnings available to equity shareholders by 1.5%, because of the fixed interest burden.
- A1.33
- B1.50Correct
- C3.00
- D0.67
Explanation
DFL = EBIT / (EBIT - Interest) = 6,00,000 / (6,00,000 - 2,00,000) = 6,00,000 / 4,00,000 = 1.50. The option 1.33 results from wrongly dividing 4,00,000 by 3,00,000, and 3.00 results from dividing EBIT by interest alone.
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