4.18 Growth and Degree of Total Leverage

This number relates a firm’s operating and financial leverage to its net income.

With respect to Net Income:

Degree of Total Leverage = % Change in Net Income /% Change in Sales

In terms of the Contribution Margin format of the Income Statement this is:

Degree of Total Leverage = Contribution Margin/Net Income = Contribution Margin/EBIT * EBIT/Net Income

Degree of Total Leverage  =  Degree of Operating Leverage * Degree of Financial Leverage

For Wal-Mart and Target collecting together parts of the above analysis:

Wal-Mart:   TTM Degree of Operating Leverage = 3.32

Target:  TTM Degree of Operating Leverage = 3.65

Wal-Mart:   TTM Degree of Financial Leverage = 1.085

Target:  TTM Degree of Financial Leverage = 1.207

Wal-Mart:   TTM Degree of Total Leverage =3.606

Target:  TTM Degree of Total Leverage = 4.408

Target as revealed above carries more financial leverage and therefore it is more sensitive to sales fluctuations than is Wal-Mart.  Recall from the price chart (repeated below for your convenience) that Target is more sensitive to the business cycle than is a “Wal-Mart.”

The degree of total leverage analysis above reinforces the conclusion that Target is riskier than Wal-Mart because of its greater operating and financing leverage.