Question

“Biscuitville” is very unusual in that it has no debt. How does that affect their DOL and/or DFL

Answer 1

In financial analysis:

Leverage means the influence of one

financial variable over some other related financial variable.

These financial variables can be sales, contribution, variable or fixed costs, Earnings Before Interest and Tax, Earning per share.

operating leverage, financial leverage, and total leverage are related to the income statement because it shows the effect of one variable/component of income statement on another variable/component of the income statement.

It can be understood clearly from these formulas.

operating leverage= Contribution/EBIT

financial leverage= EBIT/EBT

total leverage= Contribution/EBT

Contribution=sales- variable cost.

EBIT= earnings before interest and tax.

EBT= earnings before tax.

The above 3 are variable/component of the income statement.

Degree of operating leverage is not affected with no debt.

Degree of financial leverage is affected with the use of no debt.

Factors which affect financial leverage are financial fixed costs.

For example: interest on bank loans, preference dividend, interest on debt etc.

Higher Financial leverage represents higher debt financing.

No debt financing represent lower Financial leverage i.e A financial leverage of 1.