CFA Level 1: Debt Financing and Sales Change | CFA Exam Prep

Debt Financing and Sales Change

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Question

If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level, which of the following statements is most correct?

Answers

A. The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt.

B. The percentage change in EBIT will equal the percentage change in net income.

C. The percentage change in net operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income (NI).

D. Since debt is used, the degree of operating leverage must be greater than 1.

E. The percentage change in net operating income will be less than the percentage change in net income.

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Explanations

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A. B. C. D. E.

The greater the use of fixed assets, the more sensitive EBIT will be to changes in sales. Interest charges on debt are included in net income and not operating income, as the use of debt financing will have an impact on net income when sales change.

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