What is the degree of combined leverage – DCL’
The degree of effort (RSN) is a capitalization ratio, which summarizes the fact that the level of operating leverage (dol) and the degree of financial leverage on earnings per share (EPS), subject to certain changes in sales. This ratio can be used to determine the most optimal level of financial and operating leverage to use in any firm.
To illustrate, the formula:
Breaking down the ‘degree of combined leverage – DCL’
This ratio summarizes the effect of combining financial and operating leverage, and what effect this combination, or variations of this combination, has on the profits of the Corporation. Not all corporations use both operating and financial leverage, but this formula can be used if they do. Firms with a relatively high level of combined leverage is seen as more risky than firms with less combined leverage, and high leverage means higher fixed costs for the firm.
The degree of operating leverage
The degree of operating leverage measures the effect of operating leverage, which has the potential profit of the companies and shows how the earnings depends on the activity of sales. The degree of operating leverage is calculated as the quotient of the percentage change in the company’s profit before interest and tax (ebit) to the percentage change in sales over the same period.
The degree of financial leverage
The degree of financial leverage is calculated by dividing the percentage change in the company’s EPS by its percentage change in operating profit. The ratio shows how much of the company EPS affects the percentage changes in operating profit. Higher level of financial leverage means that the company has a more volatile EPS.
The degree of combined leverage example
As noted earlier, the degree of effort can be calculated by multiplying the degree of operating leverage and degree of financial leverage. Suppose the hypothetical missile and the firm had a turnover of $ 50 million for the current fiscal year, and operating profit of $40 million for the previous fiscal year, or 25% year on year (yoy). Rocket reported sales of $80 million for the current fiscal year and received $65 million for the previous fiscal year, an increase of 23.08%. In addition, the rocket announced earnings per share of $2.50 for the current fiscal year and earnings per share of $2.00 for the previous fiscal year, an increase of 25%.
Thus, the rocket had a degree of operating leverage of 1.08 and the degree of financial leverage 1. Therefore, the rocket had a degree combo arm 1.08. For every 1% change in sales rocket, its EPS will change by 1.08%.