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What is the percentage change in EPS for Strawberry, Inc (before the R&D expansion) if sales fall by 2.8%? Round to 0.01%, drop the % symbol, do not ignore the negative sign.

If operating leverage (measured by DOL) relates sales to EBIT, and financial leverage (measured by DFL) relates EBIT to net income, combined leverage relates sales to net income. It is measured by the degree of combined leverage, or DCL, and is a percentage change in net income (NI) for a 1% change in sales. DCL is the product of DOL and DFL:

DCL=DOLDFL=%NI%Sales=SalesVCEBITInterestDCL=DOLDFL=%Sales%NI=EBITInterestSalesVC

The numerator is from the DOL formula, and the denominator is from the DFL formula.

Example 1. e. What is the DCL of Strawberry, Inc. at the initial sales level of 300,000 units before the expansion of the R&D?

Using the values we found previously,

DCL = DOL*DFL = 6*1.923 = 11.54

or, (Sales VC)/(EBIT Interest) = 90,000,000/7,800,000 = 11.54

Interpretation: For a 1% change in sales (from the initial level of 300,000 units @ $350/unit), net income (NI) or, on a per-share basis, earnings per share (EPS), will change by 11.54%.

The figure below demonstrates the effect of the initial 10% increase in sales on both EBIT and EPS for Strawberry, Inc. before the R&D expansion.

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