Question

If a company has sales of 13,600,000, fixed costs of 2,120,000, contribution margin of 5,440,000 and interest expense of 490,000, what is its degree of financial leverage? Put your answer to two decimal places

Answer 1

The degree of financial leverage measures the sensitivity of a company's earnings to changes in its operating income. In this case, the company's degree of financial leverage is 11.84.

The degree of financial leverage measures the sensitivity of a company's earnings to changes in its operating income. It is calculated by dividing the percentage change in earnings before interest and taxes (EBIT) by the percentage change in net income.

In this case, we can use the following formula:

Degree of Financial Leverage = (EBIT) / (EBIT - Interest Expense)

Given the information provided:

Sales = $13,600,000

Fixed Costs = $2,120,000

Contribution Margin = $5,440,000

Interest Expense = $490,000

First, let's calculate the EBIT:

EBIT = Sales - Fixed Costs = $13,600,000 - $2,120,000 = $11,480,000

Now, we can calculate the degree of financial leverage:

Degree of Financial Leverage = EBIT / (EBIT - Interest Expense) = $11,480,000 / ($11,480,000 - $490,000) = 11.84

Therefore, the company's degree of financial leverage is 11.84.