The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS. If a 10 percent increase in sales causes EPS to increase from $1.00 to $1.50, and if the firm uses no debt, then what is its degree of operating leverage?
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A. B. C. D. E.D
These two equations could be used:
DTL = (DOL)(DFL).
EPS(1) = EPS(0)[1 + (DTL)(%Change Sales)].
Note that EPS rises by 50 percent, from $1.00 to $1.50, on a 10 percent increase in sales, so
1.50 = 1.00[1 + (DTL)(0.1)]
1.50 = 1 + 0.1 DTL
0.1 DTL = 0.50
DTL = 5.00.
Now DTL = 5 = (DOL)(DFL)
But if Debt = 0, then DFL = 1, so DOL = DTL = 5.0.