The computation and interpretation of the degree of financial leverage (DFL)

It is December 31. Last year, Torres Industries had sales of $160,000,000, and it forecasts that next years sales will be $152,000,000. Its fixed costs have beenand are expected to continue to be$64,000,000, and its variable cost ratio is 1.00%. Torress capital structure consists of a $15 million bank loan, on which it pays an interest rate of 8%, and 750,000 shares of common equity. The companys profits are taxed at a marginal rate of 40%. Given this data, complete the following sentences:

Note: For these computations, round each EPS to two decimal places.

	The companys percentage change in EBIT is .
	The percentage change in Torress earnings per share (EPS) is .
	The degree of financial leverage (DFL) at $152,000,000 is .

The following are the two principal equations that can be used to calculate a firms DFL value:

DFL (at EBIT = $X)=Percentage Change in EPSPercentage Change in EBITDFL (at EBIT = $X)=Percentage Change in EPSPercentage Change in EBIT

DFL (at EBIT = $X)=EBITEBITInterestPreferred Dividends(1 Tax Rate)DFL (at EBIT = $X)=EBITEBITInterestPreferred Dividends(1 Tax Rate)

Consider the following statement about DFL, and indicate whether or not it is correct.

All other factors remaining constant, the larger the proportion of common equity used by the firm in its capital structure, the smaller the firms DFL.

False

True