Hi guys, I am confused about interest and Degree of Total Leverage. 1)By definition, DTL is a measure of the sensitivity of net income to changes in the number of units produced and sold. 2) By formula DTL= Q(P-V) / [Q(P-V) - Fixed Cost - Interest].
If Interest increses, in 1) Net Income will decreas,and DTL decreas. However, in 2) decrease interest leads to the increase of DTL.
Can someoen explain this to me?
This isn’t true. If interest expense increases, DTL increases.
By definition:
DTL=\frac{\%\ change\ in\ Net\ Income }{\%\ change\ in\ Sales}
The amount of the change in Net Income caused by a change in Sales will be the same irrespective of interest expense. A larger interest expense will give a smaller Net Income. If you have the same amount of change divided by a smaller Net Income, it’s a higher percent change.
I encourage you to create a simple income statement (Sales, Variable Costs, Fixed Costs, Interest, Taxes, Net Income), then calculate DTL for one value for Interest, then for a higher value for Interest.
Please post your results here.