BUSINESS ADMINISTRATION
FINANCIAL MANAGEMENT
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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sensitivity of EBIT with respect of % change with respect to output
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% variation in the level of production
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sensitivity of EPS with respect to % change in level of EBIT
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no change with EBIT and EPS
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Detailed explanation-1: -The degree of financial leverage (DFL) measures the percentage change in EPS for a unit change in operating income, also known as earnings before interest and taxes (EBIT). This ratio indicates that the higher the degree of financial leverage, the more volatile earnings will be.
Detailed explanation-2: -DFL determines the percentage change in a company’s EPS per unit change in its EBIT. A company’s DFL is calculated by dividing its percentage change in EPS by the percentage change in EBIT over a certain period. It can also be calculated by dividing a company’s EBIT by its EBIT less interest expense.
Detailed explanation-3: -Its level of risk? Financial leverage increases the volatility of a firm’s earnings per share. As a firm increases its financial leverage, its EPS will rise and fall by magnified amounts in response to changes in EBIT. This makes the EPS stream riskier for investors.
Detailed explanation-4: -Financial leverage helps to examine the relationship between EBIT and EPS. Financial leverage measures the percentage of change in taxable income to the percentage change in EBIT. Financial leverage locates the correct profitable financial decision regarding capital structure of the company.
Detailed explanation-5: -EPS, of course, largely depends on a company’s earnings. For EPS calculation, earnings before interest and taxes (EBIT) is used because it reflects the amount of profit that remains after accounting for those expenses necessary to keep the business going. EBIT is also often referred to as operating income.