Where: DFL is the degree of financial leverage, Δ EPS is the change of earnings per share of common stock, and EPS is the earnings per share in the base period. If a company issues preferred shares and borrows money from a bank, it can calculate the degree of financial leverage according to the following simplified formula: earnings before interest and tax/earnings before interest and tax-interest-preferred stock dividend/1- corporate income tax: DFL=EBIT/EBIT-I-d/( 1-t).
Extended data:
The relationship between financial risk and financial leverage;
Financial risk refers to the extra risk that sovereign capital bears when the future income is uncertain due to the use of debt funds by enterprises. If the enterprise is in good operating condition and the return on investment is greater than the debt interest rate, then it will get the positive effect of financial leverage; If the business is in poor condition, the return on investment will be less than the debt interest rate.
Then you will get the negative effect of financial leverage, and even the enterprise will go bankrupt. This uncertainty is the financial risk that enterprises bear when using liabilities. The financial risk of an enterprise mainly depends on the level of financial leverage. Generally speaking, the greater the degree of financial leverage, the greater the elasticity of the return on sovereign capital to the profit rate before interest and tax.
If the profit rate before interest and tax rises, the return on sovereign capital will rise faster; If the profit rate before interest and tax decreases, the profit rate of sovereign capital will decrease faster and the risk will be greater. On the contrary, the smaller the financial risk. The essence of the existence of financial risk is that the part of operating risk borne by debt is passed on to equity capital because of debt operation.
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