If a firm has current earnings before interest and taxes of $100,000 and interest expense of $10,000, its degree of financial leverage would be:
A)10
B)1.11
C).10
D)cannot tell from this information

Question

Quizplus · Accepted Answer

Degree of financial leverage is calculated by dividing percentage change in net income to the percentage change in operating income. As we don't know the exact increase or decrease in net income due to interest payment, we cannot calculate the exact degree of leverage. However, we can use the following formula to estimate the degree of leverage:
Degree of financial leverage = Earnings before interest and taxes / (Earnings before interest and taxes - Interest expense)
Degree of financial leverage = 100,000 / (100,000 - 10,000)
Degree of financial leverage = 1.11
Therefore, the best choice is B.

If a Firm Has Current Earnings Before Interest and Taxes