Answer:
there are two formulas that measure the degree of financial leverage:
DFL = EBIT / (EBIT - interest)
DFL = % change in net income / % change in EBIT
Corporation A has a DFL of 1.75 which means that interests represent approximately 43% of EBIT.
if we assume EBIT = 100
1.75 = 100 / 100 - i
100 - i = 100 / 1.75
100 - i = 57.14
i = 100 - 57.14 = 42.86
financial break even point is where EBIT = interest expense
in this case, corporation A can be considered healthy because its EBIT is much higher than their interest expense.
Corporation B has a DFL of 83 which means that interests represent approximately 98.8% of EBIT.
if we assume EBIT = 100
83 = 100 / 100 - i
100 - i = 100 / 83
100 - i = 1.2
i = 100 - 1.2 = 98.8
financial break even point is where EBIT = interest expense
in this case, corporation B can be considered extremely leveraged because its EBIT barely covers their interest expense.
Corporation B is a much riskier investment than corporation A since its EBIT is almost at financial break even point
