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

Kaveri Ltd has a DOL of 2.5 and a DFL of 1.6 at the current level of output. If sales are expected to rise by 10%, by what percentage will EPS rise (no preference shares)?

EPS will rise by 40%. Combined leverage is the product of operating and financial leverage, 2.5 × 1.6 = 4.0. A 10% rise in sales therefore magnifies into a 4.0 × 10 = 40% rise in earnings per share.

  1. A16%
  2. B25%
  3. C40%Correct
  4. D4.1%

Explanation

Combined leverage DCL = DOL × DFL = 2.5 × 1.6 = 4.0. % change in EPS = DCL × % change in sales = 4.0 × 10% = 40%. Using 25% only applies DOL and ignores financial leverage, and 16% applies only DFL.

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