Capital Structure Analysis: Degree of Financial Leverage Calculation

Degree of Financial Leverage Calculation

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Question

Clay Industries, a large industrial firm, is examining the capital structure of one of its Lebanese subsidiaries. The management of Clay Industries has identified the following information:

EBIT $1,000,000 -

EPS $1.88 -

Interest paid $121,590 -

Sales $1,940,000 -

Cost of debt 6.60%

Given this information, what is the Degree of Financial Leverage for this operating division?

Answers

Explanations

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A. B. C. D. E. F.

B

To calculate the DFL, the financial analyst needs to determine the EBIT and interest paid for a predetermined time period. To calculate the Degree of Financial

Leverage, the following equation is used: {EBIT/[EBIT - interest paid]}. Incorporating the given information into this equation yields the following: {EBIT

$1,000,000 / [EBIT $1,000,000 - interest paid $121,590]}= 1.138.

The Degree of Financial Leverage measures the percentage change in EPS which results from a given percentage change in EBIT. Remember that any preferred stock dividends must be incorporated into the DFL calculation, and that the DFL can never be less than one.

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