Sign up  |  Log in

Question on magnifying effect of leverage

Hello everyone,

I’ve been studying “Reading #34 - Measures of Leverage” of L1, and I encountered the following statements near the end of chapter of the curriculum and Schweser, respectively:

“The farther unit sales are from the breakeven point for high-leverage companies, the greater the magnifying effect of this leverage.”

“Leverage of either type magnifies the effects of change in sales on net income. The further a firm’s sales are from its breakeven level of sales, the greater the magnifying effects of leverage on net income.”

However, according to the formula of DTL (degree of total leverage):

DTL = Q(P - V) / [Q(P - V) - F - I],

the magnifying effect (I assume it to be the percentage change in net income that results from a percentage change in sales, which is basically DTL) must get lower as Q gets higher, mathematically.

This seems to contradict to the statements mentioned in the books. I wonder if I did anything wrong?

Thanks a lot.

You’re ready to take on the CFA Program, so stop guessing where you should begin. You give us your study dates, we’ll give you the study plan. Our adaptive activity feed breaks down your 300 hours into bite-sized weekly tasks that fit into your life.

Does anyone have any thoughts on this, please? Thanks a lot.

The statement as given is wrong.

Color me shocked.

It’s true that the lower the sales, the greater the leverage.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

Wow, cool. surprise

Mystery solved. Thank you very much.