The degree of financial leverage for Aries Inc.is 3.0,and the degree of financial leverage for Common Capital Corporation is 6.2.According to this information,which firm is considered to have greater overall (total)risk?
A) Aries Inc.
B) Common Capital Corporation.
C) The degree of financial leverage is a measure of financial risk,so the only conclusion that can be made with the information given is that Common Capital Corporation has greater financial risk than Aries Inc.⎯ we cannot tell which firm has greater total risk.
D) To determine which firm has the greater total risk,we need to know the financial breakeven point of each firm.
E) None of the above is a correct answer.

Question

Quizplus · Accepted Answer

The degree of financial leverage (DFL) measures a company's financial risk by showing how much its earnings per share (EPS) can change due to a change in operating income. A higher DFL indicates higher financial risk because it means the company's EPS is more sensitive to changes in operating income, due to a higher proportion of fixed financing costs (like interest on debt). However, total risk includes both financial risk and business (operating) risk. The information provided only allows us to compare the financial risk between Aries Inc. and Common Capital Corporation, not their total risk.

The Degree of Financial Leverage for Aries Inc