Answer (D) is correct . The degree of financial leverage (DFL) is the multiple of operating income (or earnings before interest and taxes, called EBIT) over earnings before taxes (EBT). A high multiple indicates heavy use of fixed costs in the firm’s capital structure, revealed by high interest payments on debt. This firm’s EBIT is 1.5 times EBT. Thus, a given percentage change in EBIT will result in a change one-and-a-half times as great in EBT (1.5 × 5% = 7.5%).
Answer (A) is incorrect because The percentage of 1.5 results from equating the degree of financial leverage with its effect on net earnings.
Answer (B) is incorrect because The percentage of 3.33 results from improperly identifying the difference between EBIT before the increase and EBIT after the increase (7.5% – 5% = 2.5%) as the numerator to determine the degree of the effect (2.5% ÷ 7.5% = 3.33%).
Answer (C) is incorrect because Five percent results from equating the amount of the increase in EBIT with its effect on net earnings.
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