# How to Calculate DFL

Save

Investors are primarily concerned with two things, return and risk. Higher returns require a greater degree of risk. The risk is justified by the amount of revenue and profit that can be generated from the degree of financial leverage. As a general rule, when returns are higher than the costs associated with obtaining funds (financial leverage), a company can expect to see an increase in profits.

Review the DFL formula at a high level. The degree of financial leverage is the percent change in net income given a change in operating income. The exact formula is DFL = operating income ÷ (operating income - interest - (preferred dividends ÷ (1 - tax rate)).

Define the variables. For our example, let's assume a company has \$1 million in total sales. Operating costs (variable and fixed) are \$500,000. Annual interest expense is \$100,000, and preferred dividends are \$10,000 per year. The tax rate is 33 percent.

Calculate operating income or EBIT. EBIT equals sales (\$1 million) - operating costs (\$500,000). EBIT equals \$500,000.

Divide preferred dividends by 1 - tax rate. Preferred dividends (\$10,000) divided by (1 - .33) or .67 equals \$14,925.37.

Calculate DFL. The final equation should be: \$500,000 ÷ (\$500,000 - \$100,000 - \$14,925.37) = 1.3.

## References

Promoted By Zergnet

## Related Searches

Check It Out

### 4 Credit Myths That Are Absolutely False

M
Is DIY in your DNA? Become part of our maker community.