520 PART 4 Long-Term Financial Decisions
- By using the formula for DTL in Equation 12.9, it is possible to get a negative value for the DTL if the EPS for
the base level of sales is negative. For our purposes, rather than show absolute value signs in the equation, we
instead assume that the base-level EPS is positive.
Whenever the percentage change in EPS resulting from a given percentage change
in sales is greater than the percentage change in sales, total leverage exists. This
means that as long as the DTL is greater than 1, there is total leverage.EXAMPLE Applying Equation 12.8 to the data in Table 12.7 yieldsDTL6.0Because this result is greater than 1, total leverage exists. The higher the value,
the greater the degree of total leverage.A more direct formula for calculating the degree of total leverage at a given
base level of sales, Q,is given by Equation 12.9,^12 which uses the same notation
that was presented earlier:Q(PVC)
DTL at base sales level Q (12.9)
Q(PVC)FCIPD EXAMPLE SubstitutingQ20,000, P$5,VC$2, FC$10,000, I$20,000,PD
$12,000, and the tax rate (T0.40) into Equation 12.9 yieldsDTL at 20,000 units
20,000($5$2)
20,000($5$2)$10,000$20,000$12,000 6.0Clearly, the formula used in Equation 12.9 provides a more direct method for
calculating the degree of total leverage than the approach illustrated using Table
12.7 and Equation 12.8.The Relationship of Operating, Financial, and Total Leverage
Total leverage reflects thecombined impactof operating and financial leverage
on the firm. High operating leverage and high financial leverage will cause total
leverage to be high. The opposite will also be true. The relationship between oper-
ating leverage and financial leverage ismultiplicativerather thanadditive.The
relationship between the degree of total leverage (DTL) and the degrees of operat-
ing leverage (DOL) and financial leverage (DFL) is given by Equation 12.10.DTLDOLDFL (12.10)$60,000$10,0001
1 0.401
1 T300%
50%