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DFL = Percentage change in taxable income Percentage change in the operating income According to Gitman, "financial leverage is the ability of a firm to use fixed financial charges to magnify the effects of changes in EBIT on the company's earning per share." Thus, the financial leverage indicates the percentage change in earning per share in relation to a percentage change in EBIT. Accordingly, the degree of financial leverage can be calculated as per the following formula: DFL Percentage change in EPS Percentage change in EBIT 21 There will be no financial leverage if the result of the above equation is less than 1. Financial leverage is also termed as 'Trading on Equity'. The concept of trading on equity states that the company uses equity capital as well as borrowed capital while deciding its capital structure. The objective of the term trading on equity is to provide a higher return to the shareholders of the company. However, trading on equity should be used for the term financial leverage only when the financial leverage is favourable. The financial leverage has potentiality of increasing the return to equity shareholders but at the same time it cerates additional risk for the shareholders also. Z Ltd. has given the following details: Sales Variable cost Fixed cost Rs. 48,00,000 24,00,000 12.00,000 It has borrowed Rs. 10,00,000 @ 15% p.a. and its equity share capital is Rs. 10,00,000 You are required to calculate: (a) Operating leverage. (b) Financial leverage

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