The degree of financial leverage (DFL) is a relative measure of risk. If Corporation A has a DFL of 1.75 and Corporation B has a DFL of 83 describe where both corporations are to their financial breakeven point and explain which corporation (A or B) has the highest level of risk.

there are two formulas that measure the degree of financial leverage:

DFL = EBIT / (EBIT - interest)

DFL = % change in net income / % change in EBIT

Corporation A has a DFL of 1.75 which means that interests represent approximately 43% of EBIT.

if we assume EBIT = 100

1.75 = 100 / 100 - i

100 - i = 100 / 1.75

100 - i = 57.14

i = 100 - 57.14 = 42.86

financial break even point is where EBIT = interest expense

in this case, corporation A can be considered healthy because its EBIT is much higher than their interest expense.

Corporation B has a DFL of 83 which means that interests represent approximately 98.8% of EBIT.

if we assume EBIT = 100

83 = 100 / 100 - i

100 - i = 100 / 83

100 - i = 1.2

i = 100 - 1.2 = 98.8

financial break even point is where EBIT = interest expense

in this case, corporation B can be considered extremely leveraged because its EBIT barely covers their interest expense.

Corporation B is a much riskier investment than corporation A since its EBIT is almost at financial break even point

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