Certified Management Accountant Practice Exam 2025 – The Comprehensive All-in-One Guide to Exam Success!

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How is the degree of financial leverage (DFL) calculated?

(% Change in Net Income) / (% Change in EBIT)

The degree of financial leverage (DFL) is calculated by taking the percentage change in net income and dividing it by the percentage change in earnings before interest and taxes (EBIT). This ratio illustrates how sensitive net income is to changes in EBIT. When a company has a high DFL, it means that a relatively small change in EBIT will translate into a larger change in net income, highlighting the impact of fixed financing costs on profitability.

Understanding DFL is crucial for managers and investors alike since it helps assess the risk associated with the company’s capital structure. A higher DFL often indicates more financial risk, as fixed costs must be paid regardless of the company’s earnings performance. Thus, the correct calculation reflects the benefit of leverage when things go well, as well as the increased risk during downturns.

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(% Change in EBIT) / (% Change in Net Income)

(Net Income) / (Sales)

(Total Revenue) - (Total Costs)

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