By combining the degree of operating leverage with the degree of financial leverage we obtain the degree of total leverage (DTL). If a firm has a high amount of operating leverage and financial leverage, a small change in sales will lead to a large variability in EPS.

Formula 11.20

DTL = Q(P - V)  
         Q(P - V) - F - I

 

Example: degree of total leverage
Using our previous example, say Newco produces 140,000 units annually. The company's variable costs are $20 per unit, and its fixed costs total $2.4 million. The company's annual interest expense amounts to $100,000 annually. If Newco's sales increase by 20%, what is the impact to the company's EPS?

Answer:
DTL = 140,000(50-20)/140,000(50-20)-2,400,000 - $100,000 = 2.47

If Newco's sales increase by 20%, the company's EPS will increase by 49.4% (20%)(2.47).

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