What Is the Degree of Combined Leverage (DCL)?
Let me explain the degree of combined leverage (DCL) directly to you. It's a leverage ratio that captures the combined impact of the degree of operating leverage (DOL) and the degree of financial leverage on earnings per share (EPS) when sales change. You can use this ratio to figure out the most effective levels of financial and operating leverage for any company.
The Formula for the Degree of Combined Leverage
Here's the formula you need: DCL equals the percentage change in EPS divided by the percentage change in sales, which is also DOL multiplied by DFL. In this, DOL stands for degree of operating leverage, and DFL for degree of financial leverage.
Key Takeaways
The DCL formula outlines how the combined degrees of operating and financial leverage influence a company's EPS based on sales shifts. This ratio lets you identify the ideal operational and financial leverage for a firm. It also shows you how combined leverage impacts the company's total earnings.
What Does the DCL Tell You?
This ratio breaks down the effects of mixing financial and operating leverage, and how different mixes affect the company's earnings. Not every company uses both types of leverage, but if they do, you can apply this formula. Remember, a company with high combined leverage is riskier than one with lower leverage because it means more fixed costs are involved.
Degree of Operating Leverage
The degree of operating leverage shows how operating leverage affects a company's earnings potential and how sales activity influences earnings. You calculate it by dividing the percentage change in earnings before interest and taxes (EBIT) by the percentage change in sales over the same period.
Degree of Financial Leverage
For the degree of financial leverage, you divide the percentage change in EPS by the percentage change in EBIT. This ratio tells you how changes in EBIT affect EPS. If the degree is higher, it means the company's EPS is more volatile.
Degree of Combined Leverage Example
As I mentioned, you get DCL by multiplying DOL by DFL. Take a hypothetical company called SpaceRocket. It had an EBIT of $50 million this year and $40 million last year, which is a 25% increase. Sales were $80 million this year and $65 million last year, up 23.08%. EPS was $2.50 this year and $2 last year, a 25% rise. So, SpaceRocket's DOL was 1.08 and DFL was 1, giving a DCL of 1.08. That means for every 1% change in sales, EPS changes by 1.08%.
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