HP-12C DFL Leverage

Degree of Financial Leverage (DFL)

DFL tells you how much earnings per share (EPS) swings when EBIT moves, and the culprit is fixed financial cost: interest on debt, plus preferred dividends. You can write it as DFL = ΔEPS% / ΔEBIT%, or, equivalently, as DFL = EBIT / (EBIT − Interest). Say the DFL is 2. Then a 10% jump in EBIT lifts EPS by 20%, and a 10% fall in EBIT cuts EPS by the same 20%.

The more debt a firm carries, the higher its DFL. Banks are the textbook case, often landing between 8 and 15 because their leverage ratios sit around 10:1. Utilities and REITs run lower, in the 3–5 range, and a tech company sitting on a pile of cash can be close to 1. The CFA Level 2 curriculum puts DFL in a bigger picture. Multiply it by the Degree of Operating Leverage (DOL) and you get the Degree of Total Leverage, DTL = DOL × DFL, which traces how a wobble in sales eventually lands on EPS.

Applications

DFL sits at the heart of capital-structure choices. Swap equity for cheaper debt and your ROE climbs, but so does DFL, and with it the odds of going bust. Equity analysts lean on DFL to forecast how EPS will react through the cycle. Credit analysts read it alongside interest coverage and EBITDA / debt to judge solvency. Trade-off theory (Modigliani–Miller with taxes) is what explains why each firm has its own optimal DFL.

FAQ

Why do banks have such high DFL? Their whole job is moving capital around. Deposits and bonds are the fixed-cost side, and they fund loans, which is where the variable revenue comes from. A tiny shift in NIM throws EPS around, which is exactly why regulators keep a close eye on them (Basel III).

Is DFL the same as Debt / Equity? No. D/E comes off the balance sheet, while DFL is an income-statement sensitivity that hinges on where EBIT happens to be right now. So the same firm shows a different DFL from one year to the next.

How do I reduce DFL? Pay down debt, refinance at lower rates, issue equity, or simply grow EBIT. Each one shrinks how much interest weighs on the income statement.