CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Leverages
Aarav Ltd has a degree of operating leverage of 3 and a degree of financial leverage of 1.5. If sales are expected to rise by 8%, by what percentage will EPS rise, assuming the cost structure stays unchanged?
EPS will rise by 36%. Combined leverage is the product of operating leverage 3 and financial leverage 1.5, which is 4.5. Multiplying this by the 8% expected rise in sales gives a 36% increase in earnings per share.
- A24%
- B12%
- C36%Correct
- D4.5%
Explanation
DCL = DOL x DFL = 3 x 1.5 = 4.5. Percentage change in EPS = DCL x percentage change in sales = 4.5 x 8% = 36%. Option A (24%) uses only DOL and ignores financial leverage; option B (12%) uses only DFL.
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