Corporate Finance  Financial Leverage
As mentioned previously, financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company's capital structure. As a company increases debt and preferred equities, interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company.
Degree of Financial Leverage
This measures the percentage change in earnings per share over the percentage change in EBIT. This is known as "degree of financial leverage" (DFL). It is the measure of the sensitivity of EPS to changes in EBIT as a result of changes in debt.
Formula 11.19
DFL = percentage change in EPS or EBIT percentage change in EBIT EBITinterest 
Example: Degree of Financial Leverage
With Newco's current production, its sales are $7 million annually. The company's variable costs of sales are 40% of sales, and its fixed costs are $2.4 million. The company's annual interest expense amounts to $100,000 annually. If we increase Newco's EBIT by 20%, how much will the company's EPS increase?
Answer:
The company's DFL is calculated as follows:
DFL = ($7,000,000$2,800,000$2,400,000)/($7,000,000$2,800,000$2,400,000$100,000)
DFL = $1,800,000/$1,700,000 = 1.058
Given the company's 20% increase in EBIT, the DFL indicates EPS will increase 21.2%.

Professionals
Financial Leverage
This concept allows you to judge how risky a company is becoming 
Fundamental Analysis
Calculating Degree of Financial Leverage
Degree of financial leverage (DFL) is a metric that measures the sensitivity of a company’s operating income due to changes in its capital structure. 
Professionals
Operating Leverage and its Effects on a Project's Expected Rate of Return
CFA Level 1  Operating Leverage and its Effects on a Project's Expected Rate of Return. This section outlines the effects of operating leverage on a project's expected rate of return, ... 
Professionals
Business and Financial Risk
CFA Level 1  Business and Financial Risk. Examine two more types of capital budgeting risk. Learn how business and financial risk relate to a company's leverage. 
Investing Basics
EBIT (Earnings Before Interest and Taxes)
Earnings before interest and taxes, or EBIT, takes a company’s revenue, or earnings, and subtracts its cost of goods sold and operating expenses. 
Professionals
Degree of Total Leverage
CFA Level 1  Degree of Total Leverage. Learn how financial and operating leverage combine into total leverage. Provides an example showing how total leverage affects EPS. 
Markets
The 5 Types Of Earnings Per Share
A look at the five varieties of EPS and what each represents can help an investor determine whether a company is a good value, or not. 
Investing Basics
The Optimal Use Of Financial Leverage In A Corporate Capital Structure
The amount of debt and equity that makes up a company's capital structure has many risk and return implications. 
Economics
Financial Leverage In Corporate Capital Structure
Corporate management uses financial leverage to increase earnings per share and returnonequity. 
Investing
Operating Leverage Captures Relationships
Find out how fixed and variable costs interact to shed new light on old companies.

Degree Of Financial Leverage  ...
A ratio that measures the sensitivity of a company’s earnings ... 
Leverage Ratio
Any ratio used to calculate the financial leverage of a company ... 
Degree Of Operating Leverage  ...
A type of leverage ratio summarizing the effect a particular ... 
Earnings Before Interest & Tax ...
An indicator of a company's profitability, calculated as revenue ... 
Leverage
1. The use of various financial instruments or borrowed capital, ... 
Degree Of Combined Leverage  DCL
A leverage ratio that summarizes the combined effect the degree ...

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