Assume that a firm has a degree of financial leverage of 1.25. If sales increase by 20%, the firm will experience a 60% increase in EPS, and it will have an EBIT of $100,000. What will be the EBIT for this firm if sales do not increase?
A) $60,980
B) $70,946
C) $67,568
D) $57,931
E) $64,189

Question

Quizplus · Accepted Answer

The degree of financial leverage (DFL) is calculated as follows:DFL = (EBIT + Interest) / EBITGiven that the DFL is 1.25, we can solve for EBIT:1.25 = (EBIT + Interest) / EBIT1.25EBIT = EBIT + Interest0.25EBIT = InterestWe are given that the EBIT is $100,000 when sales increase by 20%. This means that the EBIT without the sales increase is:EBIT = $100,000 / 1.20 = $83,333.33Therefore, the correct answer is C) $67,568.

Assume That a Firm Has a Degree of Financial Leverage