Degree of Financial Leverage

The degree of financial leverage is a leverage ratio that measures the percentage change in a firm’s earnings per share (EPS) resulting from a 1% change in operating profit.

We can calculate the DFL of a company at a particular level of operating earnings as follows:

Annie Davis wants to determine the degree of financial leverage at earnings level of $500,000. Assuming that the interest expense is $100,000, the degree of financial leverage will be calculated as follows:

If debt increases 1%, the earnings per share will increase by 1.25%.

Note that as the fixed financing costs increase, the DFL will increase. DFL will be equal to 1 when there is no fixed financing cost. For both DFL and DOL, a value of 1 means that there is no leverage.