Question

Degree of financial leverage is measured by :

• A. $\frac{EBIT}{EAT}$
• B. $\frac{EBIT}{EBT}$
• C. $\frac{EAIT}{EBT}$
• D. $\frac{C}{EBIT}$

Answer 1

The correct option is B $\frac{EBIT}{EBT}$

Financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company's bottom-line earnings per share.

The formula for calculating a company's degree of financial leverage$\left(DFL\right)$ measures the percentage change in earnings per share over the percentage change in $EBIT$. $DFL$ is the measure of the sensitivity of $EPS$ to changes in $EBIT$ as a result of changes in debt.

Formula:

$DFL$ = $EBIT$ /$EBT$