Assume that a firm has a degree of financial leverage of 1.65.If sales increase by 20%,the firm will experience a 60% increase in EPS,and it will have an EBIT of $100,000.What will be the EBIT for this firm if sales do not increase?
A) $86,533
B) $71,867
C) $73,333
D) $90,200
E) $89,467

Question

Quizplus · Accepted Answer

We can use the formula for the degree of financial leverage:
DFL = (% change in EPS) / (% change in EBIT)

1.65 = 60% / (% change in EBIT)

% change in EBIT = 60% / 1.65 = 36.36%

We know that the original EBIT was $100,000. Therefore, the new EBIT without the 20% increase in sales would be:

EBIT = $100,000 / (1 + 0.3636) = $73,333

The closest answer choice is C.

Assume That a Firm Has a Degree of Financial Leverage