Question

If a firm’s degree of combined leverage happens to be 5 times, what precisely does that mean?

Answer 1

Degree of combined leverage (DCL) = Percentage change in EPS/ Percentage change in Sales

If the firm's degree of combined leverage happens to be 5 times, this means that 1% change in Sales will cause 5% change in Earning Per Share (EPS). The firm is vulnerable to decrease in sales, proportionate increases in EPS is more than increase in sales. This also shows that as the ratio is high, firm is at risk because of more fixed cost is involved in the firm. A lower ratio is better but in this case ratio is 5 times, which clearly tells that firm is at risk. Keeping other things constant, firm has to generate additional sales to cover it's total fixed cost.