Floweration.com: Degree of Total Leverage Calculation

Degree of Total Leverage

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Question

A financial analyst is examining shares of Floweration.com, a sprawling Internet "dot com" company, in an attempt to evaluate the firm for possible investment. In her analysis, the financial analyst has determined the following information for the most recent fiscal year:

Sales $2,250,000 -

Total fixed cost $1,300,000 -

Total variable cost $305,000 -

Interest expense $5,750 -

EBIT $645,000 -

Amortization expense $4,550 -

Given this information, what is the Degree of Total Leverage for Floweration.com?

Answers

Explanations

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Explanation

The Degree of Total Leverage (DTL) demonstrates how a given change in sales will impact a firm's EPS. The equation used for calculating the DTL is as follows:

{[Sales - variable costs] / [sales - variable costs - fixed costs - interest expense]}. Incorporating the given values for these components into the DTL equation yields the following: {[Sales $2,250,000 - variable costs $305,000] / [sales $2,250,000 - variable costs $305,000 - fixed costs $1,300,000 - interest expense $5,750]}

=3.043. While somewhat intuitively appealing, "EBIT" and "amortization expense" are not explicitly incorporated into the DTL equation.

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