Dittmar Corp. is considering an operational change that will increase its DOL from 2.0 to 3.0. It will be funding this change with debt so that its DFL will increase from 1.2 to 1.5. Analysts believe that the overall change could increase sales by as much as 10% if it is successful, but could decrease sales by 6% if it is not successful. What is the range of possible changes in EPS based on this information?
A)Decrease of 18% to an increase of 30%
B)Decrease of 9% to an increase of 15%
C)Decrease of 6% to an increase of 10%
D)Decrease of 27% to an increase of 45%
E)Decrease of 24% to an increase of 40%

Question

Quizplus · Accepted Answer

The range of possible changes in EPS can be calculated using the Degree of Total Leverage (DTL), which is the product of the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL). The initial DTL is 2.0 * 1.2 = 2.4, and the new DTL after the changes will be 3.0 * 1.5 = 4.5. The percentage change in EPS for a given percentage change in sales is equal to the percentage change in sales times the DTL. Therefore, for a 10% increase in sales, the increase in EPS would be 10% * 4.5 = 45%. For a 6% decrease in sales, the decrease in EPS would be 6% * 4.5 = 27%. Thus, the range of possible changes in EPS is a decrease of 27% to an increase of 45%.