The Impact of Leveraged Buyout on Financial Leverage
How does a leveraged buyout typically affect the Degree of Financial Leverage (DFL)?
A leveraged buyout will usually result in an increase in DFL (Degree of Financial Leverage). A leveraged buyout involves using a significant amount of debt to finance the acquisition of a company. By taking on more debt, the company's fixed interest expenses increase, leading to higher financial leverage. This results in an increase in the DFL, which measures the sensitivity of earnings per share (EPS) to changes in operating income. Therefore, the correct option is an increase in DFL. Leveraged buyouts magnify the impact of changes in operating income on EPS due to the increased interest expense associated with the higher debt levels. This heightened financial leverage can potentially amplify both gains and losses for the acquiring company.
Understanding Degree of Financial Leverage (DFL)
Degree of Financial Leverage (DFL) is a financial metric that shows how a company's earnings per share (EPS) could be affected by changes in its operating income. It measures the percentage change in EPS relative to the percentage change in operating income.
Impact of Leveraged Buyouts on DFL
When a company undergoes a leveraged buyout, it increases its level of debt to finance the acquisition. This heightened debt load results in higher fixed interest expenses, which in turn lead to an increase in financial leverage.
Significance of Increased DFL
The increase in DFL due to a leveraged buyout means that small changes in operating income can have a magnified impact on EPS. This can result in heightened volatility in earnings and greater financial risk for the acquiring company.