Select Any One Of the Following Options: A firm has a DFL of 3.5 at X dollars. What does this tell us about the firm?If sales rise by 3.5% at the firm, then EBIT will rise by 1%. If EBIT rises by 3.5% at the firm, then EPS will rise by 1%.If EBIT rises by 1% at the firm, then EPS will rise by 3.5%If sales rise by 3.5% at the firm, then EBIT will fall by 1%.
Question
Select Any One Of the Following Options: A firm has a DFL of 3.5 at X dollars. What does this tell us about the firm?If sales rise by 3.5% at the firm, then EBIT will rise by 1%. If EBIT rises by 3.5% at the firm, then EPS will rise by 1%.If EBIT rises by 1% at the firm, then EPS will rise by 3.5%If sales rise by 3.5% at the firm, then EBIT will fall by 1%.
Solution
The correct option is: If EBIT rises by 1% at the firm, then EPS will rise by 3.5%.
DFL, or Degree of Financial Leverage, is a ratio that measures the sensitivity of a company's earnings per share (EPS) to fluctuations in its operating income, as a result of changes in its capital structure. It measures the percentage change in EPS for a unit change in earnings before interest and taxes (EBIT), and is used to evaluate the risk associated with the financial policy of a company.
In this case, a DFL of 3.5 means that for every 1% change in the company's EBIT, there will be a 3.5% change in the company's EPS. Therefore, if EBIT rises by 1% at the firm, then EPS will rise by 3.5%.
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