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

Sales of a company are expected to rise by 8%. Its DOL is 2.5 and DFL is 1.6. By what percentage will EPS be expected to change (no preference shares)?

EPS is expected to rise by 32%. Combined leverage is DOL times DFL, which is 2.5 × 1.6 = 4.0. Multiplying by the 8% rise in sales gives a 32% change in EPS. Using only operating leverage would give 20%, which ignores the financial leverage effect.

  1. A12.8%
  2. B20.0%
  3. C32.0%Correct
  4. D4.0%

Explanation

DCL = DOL × DFL = 2.5 × 1.6 = 4.0. Percentage change in EPS = DCL × change in sales = 4.0 × 8% = 32%. Using only DOL gives 20%, which ignores financial leverage, and 12.8% uses DFL × sales change.

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