Question

A firm has EBIT of $375,000, interest expense of $75,000, preferred dividends of $6,000 and a tax rate of 40 percent. The firm's degree of financial leverage at a base EBIT level of $375,000 is

Answer 1

Answer: 1.29

Step-by-step explanation:

The following can be deduced from the question:

EBIT = $375000

Interest expense = $75000

EBT = EBIT - Interest Expense

= $375000 - $75000

= $300000

Before tax preference dividend

= Preferred dividend / (1 - Tax rate)

= 6000 / (1 - 40%)

= 6000 / 60%

= 6000 / 0.6

= $10000

The firm's degree of financial leverage will then be:

= EBIT / (EBIT - Interest expense - Before tax preference dividend)

= 375000 / (375000 - 75000 - 10000)

= 375000 / 290000

= 1.29

Therefore, the firm's degree of financial leverage is 1.29.