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

Sharma Textiles Ltd has a degree of operating leverage (DOL) of 2.5 and a degree of financial leverage (DFL) of 1.6. What is its degree of combined leverage (DCL), and what does it indicate?

DCL equals DOL multiplied by DFL, so 2.5 x 1.6 = 4.0. It shows that a 1% change in sales produces a 4% change in earnings per share, combining both operating and financial risk.

  1. A4.0; a 1% change in sales causes a 4% change in EPSCorrect
  2. B4.1; a 1% change in EBIT causes a 4.1% change in EPS
  3. C0.64; a 1% change in sales causes a 0.64% change in EPS
  4. D4.0; a 1% change in EBIT causes a 4% change in sales

Explanation

DCL = DOL x DFL = 2.5 x 1.6 = 4.0. It measures the percentage change in EPS for a 1% change in sales. Option 4.1 wrongly adds the two leverages, and 0.64 divides them instead of multiplying.

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