If debt financing is used,which of the following is correct?
A) The percentage change in net operating income is greater than a given percentage change in net income.
B) The percentage change in net operating income is equal to a given percentage change in net income.
C) The percentage change in net operating income depends on the interest rate charged on debt.
D) The percentage change in net operating income is less than the percentage change in net income.
E) The degree of operating leverage is greater than 1.

Question

Quizplus · Accepted Answer

If debt financing is used, the company has to pay interest on the loan, which reduces net income. As a result, the percentage change in net operating income is less than the percentage change in net income. This can be explained by the concept of financial leverage, where the use of debt magnifies the effect of changes in net income on net operating income. The degree of operating leverage (DOL) could be either greater than or less than 1, depending on the specific circumstances, but it is not directly related to the use of debt financing. Therefore, choices A, B, C, and E are incorrect.

If Debt Financing Is Used,which of the Following Is Correct