Category: Level I Corporate Finance

Typically, the more capital a company wants to raise, the more expensive it will be for each additional increment; i.e., as its capital budget grows, its marginal cost of capital (MCC) increases.  Because a company will undertake a project only when that project’s internal rate of return (IRR) is greater than the cost of capital…

The degree of total leverage (DTL) is defined as: \[DTL\ =\ \frac{\%\ change\ in\ Net\ Income}{\%\ change\ in\ Sales}\ =\ \frac{\dfrac{\Delta Net\ Income}{Net\ Income}}{\dfrac{\Delta Sales}{Sales}}\] Suppose that a company has only variable expenses – 70% of sales – and no interest expense; taxes are 40% of EBT.  If Sales are $100,000 and ΔSales is $1,000, then,…

The degree of financial leverage (DFL) is defined as: \[DFL\ =\ \frac{\%\ change\ in\ Net\ Income}{\%\ change\ in\ EBIT}\ =\ \frac{\dfrac{\Delta Net\ Income}{Net\ Income}}{\dfrac{\Delta EBIT}{EBIT}}\] Suppose that a company has no interest expense, and that taxes are 40% of EBIT.  If EBIT is $20,000 and ΔEBIT is $300, then, taxes will be $8,000 (= $20,000…

The degree of operating leverage (DOL) is defined as: \[DOL = \frac{\%\ change\ in\ EBIT}{\%\ change\ in\ Sales}\ =\ \frac{\dfrac{\Delta EBIT}{EBIT}}{\dfrac{\Delta Sales}{Sales}}\] Suppose that a company has only variable expenses, and those are 70% of sales.  If Sales are $100,000 and ΔSales is $1,000, then, expenses will be $70,000 (= $100,000 × 70%) Δexpenses will…