Question

f a​ firm's operating and financial leverage are such that a 10 percent change in sales revenue produced a 20 percent change in​ EBIT, and a 10 percent change in EBIT led to a 20 percent change in earnings per​ share, what percentage change in earnings would you expect should revenues decline by 25​ percent?

If sales revenues will decline by 25​ percent, what percentage change in earnings would you​ expect?  ​(

Answer 1

Degree of operating leverage = % change in EBIT / % change in sales = 20% / 10% = 2

Degree of financial leverage = % change in earnings per share / % change in EBIT = 20% / 10% = 2

If sales revenues decline by 25% :

Degree of operating leverage = % change in EBIT / % change in sales

2 = % change in EBIT / 25%

% change in EBIT = 25% * 2 = 50%

Thus if Sales declines by 25%, then EBIT will decline by 50%

Degree of financial leverage = % change in earnings per share / % change in EBIT

2 = % change in earnings per share / 50%

% change in earnings per share = 50% * 2 = 100%

Thus if Sales declines by 25%, then earnings per share will decline by 100%