Question 1
"Degree of Operating Leverage" (DOL) measures the sensitivity of:
View Explanation
DOL measures how much Operating Profit (EBIT) changes for a 1% change in Sales. It reflects business risk arising from fixed operating costs. (DFL measures EPS sensitivity to EBIT).
Question 2
Combined Leverage measures the total risk of the firm and is calculated as:
View Explanation
Combined Leverage = Degree of Operating Leverage × Degree of Financial Leverage. It measures the sensitivity of EPS to changes in Sales.
Question 3
A firm with high Operating Leverage and high Financial Leverage is considered:
View Explanation
High operating leverage means high fixed costs. High financial leverage means high debt/interest. A small drop in sales can lead to massive losses or bankruptcy.
Question 4
At the "Financial Break-even Point", the Earnings Per Share (EPS) is:
View Explanation
Financial Break-even Point is the level of EBIT at which EPS is zero. It is the point where operating profit is just enough to cover fixed financial charges (Interest + Preference Dividend).
Question 5
If EBIT is equal to the Indifference Point level:
View Explanation
The indifference point is specifically calculated to find the EBIT level where the EPS outcome is identical regardless of the financing option chosen.
Question 6
Degree of Financial Leverage (DFL) is calculated as:
View Explanation
DFL measures the impact of interest (fixed financial cost). It is Operating Profit (EBIT) divided by Profit Before Tax (EBT). DFL = EBIT / (EBIT - Interest).
Question 7
Calculate the Degree of Financial Leverage (DFL) if EBIT is ?1,00,000, Interest is ?20,000, and Tax rate is 30%.
View Explanation
DFL = EBIT / (EBIT - Interest). DFL = 1,00,000 / (1,00,000 - 20,000) = 1,00,000 / 80,000 = 1.25. Tax rate is irrelevant for DFL calculation (unless Preference Dividend exists).
Question 8
Financial Leverage is considered "Unfavorable" when:
View Explanation
If the firm earns less on its assets (ROI) than the interest it pays on debt, using debt reduces the return to shareholders (Negative Leverage).
Question 9
If a firm has ZERO fixed operating costs, its Degree of Operating Leverage (DOL) will be:
View Explanation
DOL = Contribution / EBIT. If Fixed Cost is 0, then Contribution = EBIT. So, DOL = Contribution / Contribution = 1. This implies no operating leverage (1% change in sales = 1% change in EBIT).
