Finance Formulas / July 19, 2018 / Rory Wise
The higher the DFL, the more volatile earnings per share (EPS) will be. Since interest is a fixed expense, leverage magnifies returns and EPS, which is good when operating income is rising, but can be a problem during tough economic times when operating income is under pressure.
Consider the following example to illustrate the concept. Assume hypothetical company BigBox has operating income or earnings before interest and taxes (EBIT) of $100 million in Year 1, with interest expense of $10 million, and has 100 million shares outstanding. (For the sake of clarity, let’s ignore the effect of taxes for the moment.)
We Also Think You’ll Like