-~ 9

171
-~I
.'\'\ _, I
170 -~
BASIC FINANCIAL MANAGEMENT LEVERAGE ANAL VSJS
I~, I l7
To continue with above example, the DOL and the DFL at the sales level of 1000 units ·•iJJ· '(" l;,'lfiYW.r' 1,,,,Ji,1jr 1 ,i;rc {,f~.tr-. ,. ~i\r,~~,y;,c/-'.fi;,;1;1F,P~i;.(" ,__,i;J:ir"'jJ~•(,l:i,!l;JIJ;•l='.:4:lfl;
are 1.5 and 1.11. The Degree of Combined Leverage (DCL) is: ; • ' !;~;'/:i,'.r;~ o~:r:'lti,pr,.ra,1\. ,l;'t'.1:r. ,w,eo11':,1;tr.t:1f&i11,1't\Tf'P''r.i,l~\lr,f,;r,; l~!,:. ,,;ti~iJ\~t.~ •t•r:::!~:f~ff•
DCL = DOL x DFL ~-j De
1.5 X 1.11
.1~-~;_J:.;;;t:~;;,::;;;;~/~;~;;;~~-~;;;~;~~:'.~;:;;;.-Li~*:.i_;~;.;;i;
;;;;•,·• t~~,:;r~~f~:~1('.(:_.. i71-o/ti)'• •~,•Uilir:••1f.~~~;~(Zf7)~ ,f, f:,f:f \!~ :.trr.ttil:t'!}~f_."iJ ~~ •.~'- ,'.·, ,.,_.t.,,t··J, .-1 ', , • ,,. •, ' ~'-"
1
1.66
b.l
1· De
This means that for every 1% increase in sales level, the EPS will increase by 1.66%. It ,i~~;:;~:;~::·,~zt!~~~·~,_-:·:--~~ff:ff~~:::~?~::;:i*~0f¥t~j)!~{J~:/tl{
may be verified by taking the sales level of 1000 units and increasing it by say, 10% as ::~~,•~:i11~•tmf!:-:m.,"',~(~rmrt-~~~~"i~.J.~J~,..,.\\-,:•::.-r~,
follows: 1

~ti:;,. :Sj-~,.~~~:-/(i~~'i,~7
:~Jc&~~:t:1.:J,r,-~:,·,·["' ••:•::t·••~~.'. r:·:t:r-:~:1~
:~:,,?~1t\'.~i;~.~:~t'.:;·Y:i~ r~ / Ill
•y:r-·-:,.p:--:'.,"" >: ;_., · 'i:\'h'.'i.t-: 11
b~iit5>•:.~r-m~~fsi~q·_.~,~-1~,C.
1
Urut.s'sola . ·st::~. : -:: ··,. i\. :· •.• ):\i_ ·, · •_ft
''.'.",',=•fF~?,fcJi"'~~· -~~ 7-~Jh,;\;; . '?:5-..1';fi.f.i'Jf;:
"Sal~s <ifr IO -per urii;_ ;,_:· , , , : .,:fr' !t:[;P:~•.Pl'.t/1/;'1,J"P"' '•' •. :;,:r,:0~~r~fi7.f~ (if.Y:~ff.~>t,t~~~r•- - n-i and
~t~J~~v,r~~ ~-;;~,.; ,· ·:'..·-:_.--;, ·.:.).··-;: ·~"':": ':/r-:',f.::J~~ ~:". ~.~i~-·r~~~ti:'l ?'·=~·tp·:t~~~~t~t~Y.:t:~
- Varia~le C9~f@"f 1.i~fJriti{·.i~"-·'.,'. · . ~ -:"/cl,i;;,\f,:t1':,,r:!•t~i.lf'J•,S,.,,.,h,,fiWcl1~~r.i,~t\i"•~f~~~~i.Wtil~~i1 comb
~~~li{ti'1m·_' .· \"/ . ;:,?; how
-'-F\xed:(fosts ·.
~n~·.:-:
'j:·~;..· . 61.:.m;·f7~i~t<1:J
:~""•=·~,1,,.,r,~.,.,m""•· rt.rrt:.r:::::;;:;£,ti:;,~~?¥( : ~;~· ;iif;. ,; ·~i;,
... r;;/;;m~fot,r0?c~f"1•~J;,d.-:;; • ••-· · .,. , · p/i-' '· ~
~, · ', '.;..-;:.·:/ ,, ..:.:•~ ·:•11t-~ .'~ :;: , _': ; / .:>., _I
1
;_- :t c,,
,;,~}~~}if
•i.:.:::_!.::;;;tt,;, 1 ~•·,.
:-f'.•.:...L ~, :--: \/>/{!}..,i}}JJ'#',-~;;J.>;.$.~'r!:'~~'!? .~:.1::1~~---
~. Solu

,JfJ~st
Profit blefore Wax ", .
_,:,. ·~~:!:>·.
: :
ffi: ~- ;·: IIH¥••>#•1ikMi4i'i94MUil
Tlix:@30%' .' .- · .'?'; Z,'.:;·' " . ·
i>~ofit afuir·4111X • · .: ,. ' .ii-!~.-;, ., · . ,.: ;_.~ ~---
. . , , . I" !w-"'" "' ' . . , :. ,~ ..,. .' 1@;1Jljf1)-
' Numb~r-ofEquity-shares -! ·: ,,o::.t . .'. ,'1500:ii..:· ;.
Calculate the degree of operating leverage (DOL), degree of financial leverage (DFL) and
~~.s . . · . · . · -~ Mr~•:·:··•'.'!'~-· :~.5~~$:,,.,. , the degree of combined leverage (DCL) for the following firms.
FirmA FirmB FirmC
8
The sales level has increased by 10% from r 10,000 tor 11,000, whereas the EPS has
increased by 16.67% from r 2.52 to r 2.94. The % increase in EPS is 1.66 times that of 1. Output (Units) 60,000 15,000 1,00,000
increase in sales level. This coefficient 1.66 is the DCL and is the same already calculated. 2. Fixed costs (r) 7,000 14,000 1,500
Thus, the CL explains as to how the 01 and FL interact and a change in sales level 3. Variable cost per unit (r) 0.20 1.50 0.02
produces a magnified change in the EPS. The CL may be interpreted as follows : 4. Interest on borrowed funds (r) 4,000 8,000
....;. 5. Selling price per unit m 0.60 5.00 0.10 Sales
Solution:
}-7:i·.'.'.~Ii'.~~.'. FirmA FirmB FirmC
ft4 will r
opera
.. beco
·1;;i~fE;\:;r:~;r
..... ,
:;·.'. ::.;.r._~_,,;"- ._:: ...~- '' ..:, •....;..;. ....... .. ;, . . ...-;...__ .,.,..
Output (Units)
Selling Price per unit (r)
60,000 15,000 1,00,000
.1'!ffl~?.fi'l':i'f\l;~T':r.i'; ,,. ,fly_,. / i,"1 :t,.a,";.' 0.60 5.00 0.10 V
' ~-~ .-: ,:,:·ir~f-~r-,.;:.r-,rf ,~f;.,,:~-;_;. .". ·A~l: '• (11l'"il.H?:' Variable Cost per unit (r)
I
0.20 1.50 0.02
Contribution per unit :r) 0.40 3.50 0.08 ':-l-::7
Total Contribution r 24,ooo 52,500 8,000
-Fixed Costs 7,000 14,000 1,500
c;i.:" EBIT 17,000 38,500 6,500
_. ":":,;;,t"'Z!:'•..r•,i~.~;~~".i;,f,;~;~.:· ,;,,,_", '· -~ - Interest tttf
. ~-:t hft:Y7')i(~...:1','l\i.1:0:-~t'ifi.f'rr,.y.r._~.;! ~f: ~~f,:-,~~-r I.lit; r •.', r,r;r; r·1 ; ti · 4,000 8,000 .', _ :--_
- I
Profit before Tax (PBT) 13,000 30,500 6,500 - -~ IIllu
·/;~;0~_/'.J2;_Jf-:t~~J.;;/_.,:';i:~(;)~_) Contribution 24,000 52,500
Degree of Operating Leverage : = 8,000 l X
,•~)')jJ.'ffc~l'iJ:1;.111 · · • ,,1>1it•fi,_''·°". ·r_,,,_,_••_•_:·,,,J,. EBIT 17,000 38,000
·· -~ii~~~~;.!i· .r • 6,500 the ll
=1.41 =1.36 = 1.23 i va ria
2,500
•,tl
tl. 1
 i.n 173
BASIC FINANCIAL MANAGEMENT LEVERAGE ANALVSIS

PBT =
Degree 8' Financial Leverage : EBIT 17,000 38,500 Solution:
13,000 30,500 6,500 Statement of Operating Leverage
=1.31 =i.26 =l.00 Particulars 2500 Units 3000 Units
Degree of Combined Leverage : Contribution
PBT = 24,000 52,500 !QQQ Sales@ f 14 per unit '(35,000 f 42,000
13,000 ?0,SOO 6,500 Variable Cost @f 9 per unit 22,500 27,000
= 1.85 =1.72 =1.23
---
Contribution 12,500 15,000
Fixed Cost 10,000 10,000
iIJJ'!lsh'ation-S~t ·j EBIT 2,500 5,000
A firm has sales of? 10,00,000, Contribution Margin of 30% and fixed costs off 1,50,000 Contribution 12,500 15,000
and debt of f 8,00,000 at 10% rate of interest. What are the operating, financial and Operating Leverage = EBIT 2,500 5,000
combined leverages? If the firm wants to double its Earnings before Interest and Tax (EBIT),
=5 3
how much of a rise in sales would be needed on a percentage basis? [B.Com., D. U., 2013}
Solution: Calculation of Fixed Cost :
Statement of Existing Profit Break Even Level = 2000 units
Sales Selling Price = f 14 per unit
r l(},00,000
Contribution @30% Variable Cost = f 9 per unit
3,00,000
-Fued Cost Contribution = t 5 per unit
EBIT Therefore, Fixed Cost = r 10,000
1,50,000
-Interest@ 10% on t 8,00,000 I
80,000
Profit before Tax (PBT) \ Ill\J,str~tion:;~,~~
70,000
-----
Operating Leverage = · Contribution _ 3,00,000 _ The balance sheet of Well Established Company is as follows:
I. EBIT - 1,50,000 - 2 Liability Amount Assets Amount
Financial Leverage = EBIT 1,501000 Equity Share Capital f 60,000 Fixed Assets f 1,50,000
PBT = 70,000 = 2·143 50,000
Retained Earnings 20,000 Current Assets
i Sales needed to Double the EBIT : Operating leverage is 2 times i.e., 1% increase in sales 10% Long-term Debt 80,000
will result in 2% increase in EBIT, or 50% increase in sales volume causes a 100% increase in
operating profit or EBIT. Thus, at the sales of ? 1,50,000, operating profit or EBIT will Current Liabilities 40,000
r
become f 3,00,000 i.e., double the existing one. 2,00,000 2,00 ,000
Verification: The company's Total Assets Turnover Ratio is 3 : 0, its Fixed Operating costs are
Sales f 15,00,000 f 1,00,000 and its Variable Operating cost ratio is 40%. The income-tax rate is 30%.
f Variable Cost (70%) Calculate for the Company the different types of leverages given that the face value of the
1~ share is t 10.
Contribution (30%) 4,50,000
Fixed Costs Solution:
1,50,000
EBI'P -- Sales
3,00,000 Total Assets Turnover Ratio = Total Assets
--
Sales
iI / Illustration 6.3-! 3
= 2,00,000
X corporation has estimated that for a new product, its break-even _point is 2,000 units if So, Sales = f 6,00,000
Sales 6.00,011(1
I 1he item is sold for f 14 per unit; the cost accounting department has currently identified
Variable Operating Cost (40%) ~.40,000
' variable cost of f 9 per unit. Calculate the degree of operating leverage for sales volume of - ·--
2,500 units and 3,000 units. Contribution 3,60.000
•
 175
174 BASIC FINANCIAL MANAGEMENT LEVERAGE ANALYSIS
1
a
.l...i,~\,
- Fixed Operating Cost 1,00,000 Calculation of different leverages (Q Ltd.)
Operatin1 Leverage = Contribution/EDIT = f 700 laca!T 300 laca
EBIT 2,60,000
- Interest (10% of 80,000)
= 2.33
8,000 = EBIT/Profit before Tax '" f 300 laca!T 200 lacs
Financial Leverage
PBT 2,62,000 = 1.5
Tax@30% 76,600 Combined Leverage = Contribution/Profit before Tax =OL x FL
PAT 1,76,400 = 3.6
Number of shares 6,000 The operating leverage is higher in case of Q Ltd. and hence it has higher degree of ~j
EPS f 29.40 operating or businea1 riak. However, both the companie• have same degree of financial
Degree of Operating Leverage leverage. Hence, both die firms have same financial risk. The combined leverage of Q Ltd. is
= Contribution/EBIT
~.6 and ill higher than P Ltd. Therefore, on the whole P Ltd. seems to be having lower risk as tr~
3,60,000
= 2,52,000 = 1 ·38 compared to Q Ltd.
Degree of Financial Leverage EBIT/fBT :Uf1ritiit~~•ijt~~f>;:
2,60,000
= 2,52,000 = 1.o3 Given below the following data of two companies :
RLtd. $Ltd.
Degree of Combined Leverage = 1.38 x 1.03 = 1.42
40,00,000 35,00,000
Sales Cf)
Note : In this question, the operating leverage, financial leverage and the combined Variable Cost 30% of Sales 30% of Sales
leverages are to be calculated for which the detailed income statement is required . Fixed Cost (f) 2,50,000 3,00,000
Therefore, the sales level, as a first step, is calculated with the help of Total Assets Turnover 14,00,000 1,60,000
Ratio. Interest ("l
Calculate degree of Operating Leverage and degree of Financial Leverage.
[ Illustration 6.S (B.Com D. U., 2009}
·tn
~ -I .,
The following information is available in respect of two firms, P Ltd. and Q Ltd. : Solution.:
Calculation of Operating and Financial Leverages :
(Figures in f Lacs)
PLtd. QLtd. RLtd. SLtd.
Sales 500 1000 Sales "40,00,000 "35,00,000
- Variable cost
Contribution
200
300
300 Less : Variable Cost 12,00,000 10,50,000
nj
700 Contribution 28,00,000 24,50,000
-Fixed cost 150 400
EBIT Less : Fixed Cost 2,50,000 3,00,000
150 300
-Interest 50 100 Earnings before Interest and Taxes 25,50,000 21,50,000
Profit before Tax
--
100
--
200 Less : Interest 14,00,000 1,60,000
tE
You are required to calculate different leverages for both the firms . Profit before Tax 11,50,000 20,00,000
Solution.:
Contribution Contribution .
Calculation of different leverages (P Ltd.) Operating Leverage
EBIT EBIT
Operating Leverage = Contribution/EBIT = f 300 lacs/?' 150 lacs 28,00.000 24,50,000
2 = 25,50,000 = 1.o98 =21,50,000 = 1.139
Financial Leverage EBIT/Profit before Tax = f 150 la~ 100 lacs EBIT EBIT
I5 Financial Leverage
PBT PBT
Combined Leverage Contribution/Profit before Tax = OL x FL
25,50,000 _ 21,50,00Q
3
= 11,50,000 = 2·217 - 20.00,000 =: 1.o75
.~
/
I
. ,. . . - - . . ,, ~'V-'/-'6.N'. ~""'~1;,o_~ \ • 1 ~...~J ~")l '. .<:-''!'." l .....:cNO'"'~"-,.,,-, ,.,.h -,-.;-,~.-.~ •- •• ~ · •- • .
:-}.
tb~
 176
BASIC FINANCIAL MANA,9EMENT
,;: LEVERAGE ANALYSIS 1n
Illustration:~; t
A fam has sales of f 15,00,000-, Variable cost of f 8,40;000 and Fixed cost of
f 1,20,000. It has a debt of" 9,00,000 at 9 perceat and equity off 11,00,000. Consider the given information for XYZ Ltd.:
{i} What is the firm's ROI (Return on Investment)? (fin lakhs)
(ii) Wbat are the operatipg and financial leverage of the firm? Sales {Variable costs 70% of Sales} 8,000
EBIT 1,950
J (iii} ?f the sales drop to "9,00,000, what will be the new E:&IT! Verify.
PBT 950
(B,Com., D.U., 2011}
J Tax Rate 30%
Solution: Caculate different type of leverage . Calculate percentage change in earnings per share if
_\
Income Statemeni of the Firm sales increase by 5 per cent. [B. Com., D. U., 2/Jl 61

Sales Solution: ,
J f 15,00,000 Given information about Income Dtatement can be presented as follows:
- Variable Costs (56%)
8,40,000
(fin lakhs)
J Contribution Sales
6,60,000 f 8,000·
- Fixed Costs - Variable Costs@70%
f 1,20,000 5,600
Contribution
i"" EBIT 2,400
6,40,000 - Fixed Costs
j - Interest 450
81,000
""' EBIT 1,950
Profit before Tax 4,69,000 Jnt,)rest 1,000
J Profit before Tax 950
(i) EBIT "5,40,000 1 = 27%, -Tax@30%
Return on Investment: Debit+ Equity - r 9,00,000 + 11,00,f O 285
J Profit after Tax 665
'!II!' ·
{ii) Operating Leverage : Contribution = f 6,60,000 = 1.222 Contribution 2,400 = 1.231
J; Operating Leverage = EBIT
EBIT f 5,40,000 = 1,950
EBIT
"5,40, 000 Financial Leverage = PBT 1,95o= 2.053
Fin anC1·a1 Leverage: EBIT
PBT - - - = 1.176 960
f 4,59,000
Combined Leverage (CL)= OL x FL= 1.231 x 2.053 = 2.527
(ml Decrease in Sales = f 6,00 000 i.e., "600,000~ 15,00,000 = 40,, If sales increase by 5% then EPS would increase by:
As per OL, EBIT will decrease by 40 x 1.222 = 48.8% Increase in EPS = 5 x CL = 5 x 2.527 = 12.63%
1
i.e., from f 5,40,000 to f 2,76,480 (5,40,000 x (1- .488). Th~ can be verified as So, EPS would increase by 12.63%.
follows: · ,

Sales f9,00,000
- Variable Costs (56%) 5,04,000 Calculate Operating and Financial Leverage from the following data ofGogna Ltd.:
Contribution 3,9&,000 Earning Before Interest and Taxes {EBIT) ( 20,00,000
- Fixed Costs 1,20,000 Profit After Tax (PAT) '( 9,00,000
Operating Fixed Cost ( 15,00,000
EBIT 2,76,000 Tax Rate 40o/,
I Hence, verified. The difference of Rs 480 is appearing because bf approximation in If the company wants to increase its PAT by 40'l>, what should be the percentage·rise in
calculation ofOL. EBIT? [B.Com., D U. 2012]

II
 ---- ------ I
179
BASIC ANANCIAL MANAGEIIEHT LEVERAGE ANALYSIS I
178 'j

Solution: :ilil('i·&ationi'6'.'ll
Contribution '( 35,00,000 1
Find out the Financial leverage from the following data :
- Fixed Cost 15,00,000
t'25,00,000
Net Worth
20,0,000 3 :1
I.
EBIT Debt/Equity
- Interest 5,00,000 12% I
Interest rate ,Ci
PBT 15,00,000 r20,oo,ooo
Operating Profit
-Tax@40% 6,00,000 .
Solution: 1,
PAT 9,00,000 r 25,oo,ooo (
Net Worth
Debt/Equity 3: 1
Contribution '( 35,00,000 ,I i
Operating Leverage (O.L.) = EBIT ='( 20,00,000 = 1.75 Hence,Debt t'75,00,000 '
EBIT 20,00,000
. . EBIT . '( 20,00,000
Financial Leverage (F.L.) = PBT = '( 15,00,000 = 1.33 -Interest@ 12% on 75,00,000 9,00,000 I
PBT 11,00,000
If the company wants to increase PAT by 40%, then% increase in EBIT should be 30%
I
(i.e. , 40 .;- 1.33). . . EBIT 20,00,000
Financial Leverage PBT ll,00,000 = 1.82
= =
Verification :
New EBIT ('( 20,00,000 + 30%) '( 26,00,000 1 mustra~on;_e,:121
- Interest 5,00,000 r
The following information is available for ABC & Co. :
PBT 21,00,000
-Tax@40% 8,40,000 EBIT '( 11,20,000
--f
Profit before Tax 3,20,000
New PAT 12,60,000
Fixed costs 7,00,000
Increase in PAT (3,60,000 + 9,60,000) 40% 4,.
Calculate% change in EPS if the sales are expected to increase by 5%.
Illustration 6.1"0 J Solution:
In order to find out the % change in EPS as a result of 'I, change in sa!es, the combined
Find uut Operating leverage from the following data :
leverages should be calculated as follows :
...
Sales '( 50,000 Operating Leverage = Contribution/ EBIT
Variable Costs 60% = '( 11,20,000 + f 7,00,000 / 11,20,000
Fixed Costs '( 12,000 .....
= 1.625
Solution: Financial Leverage = EBIT/Profit before Tax
Sales t'50,000 = ?' 11,20,000l'J,20,000
......
-Variable Cost at 60% 30,000 = 3.5
Contribution 20,000 Combined Leverage = Contribution/Profit before Tax = OL x FL
-Fixed Cost 12,000 : 1.625 X 3.5 : 5.69. ......
Operating profit - '( 8,000 The combined leverage of 5.69 implies that for 1% change in sales le,-cl, the,
Contribution _ 20,000 _ EPS would be 6.69%. So, if the sales are to increase by 5'11, then the 'ii inazase m
Operating Leverage = Operating Profit - 8,000 - 2·50 EPS would bs5 x 5.69 = 28.45%.
"
t...
 \I I
180 BASIC RNANCIAL MANAGEMENT LEVERAGE ANALYSIS 181
I !, f~
i ~l#sll-a,ipri:'.il'o: if Profit before Tax 1,400 1,700 1,100
Financial Leverage 1.43 1.18 1.82
XYZ and Co. has three financial plans.'before it._Plan I, Plan Il and Plan m. Calculate
(EBIT I Ptofit before Tax}
'
operating and fmancial leverage for the firm on the basis of the following information and
arso find out the highest and-lowest value of combined level'age: Situation C:
, EBIT r 1,000 r 1,000 "1,000
Production 800 Units 600 300 900
-hlterest @ 12%
Selling Price per unit fl5 Profit before Tax 400 700 100
Variable cost per unit . no Financial Leverage 2.5 1.43 10.0
Fixed Cost : Situation A r 1,000 (EBIT / Profit before Tax)
Situation B r2,ooo
Calculation of Combined Leverage : The combined leverage may be calculated by
Situation C ra,ooo multiplying the operating leverage and financial leverage for different combination of
Capital Structure Plan I Planll Planm Situation A, B & C and the Financial Plans, I II & III as follows :
Equity Capital f5,000 f7,500 f2,500 Situation A SmiationB Situation C
12% Debt 6,000 2,500 7,500 Plan I 1.66 2.86- 10.0
Plan II 1.47 2.36 5.72
Solution:
J: Planill 1.90 3.64 40.0
Calculation of Operating Leverage : The calculation of combined leverage shows the extent of the total risk and is helpful to
Situation A SUuationB Situation C understand the variability ofEPS as a consequence of change in sales levels. In this case, the
Number of unit sold 800 800 800 highest combined leverages is there when financial plan III is implemented in situation C;
J and lowest value of combined leverage is attained when financial Plan II is implemented in
Sales@fl5 f 12,000 f 12,000 r12,ooo
situation A.
Variable cost@ " 10 8,000
Contribution 4,000 4,000 4,000 1:1nustra~ion ,s!?-4 e
Fixed-Cost 2,000 3,000
The following data is available for XYZ Ltd.:
EBIT 3,000 .2,000 1,()00
Operating Leverage (Contribution/ E:S-IT) 1.33 .2.00 4.00 Sales "2,00,000
- Variable cost@ 30% 60,000
Calculation of Financial Leverage : Contribution 1,40,000
Plan I PlanH Planm Fixed Cost 1,00,000
Situation A :
ra,ooo ra,ooo ra,ooo EBIT 40,000
EBIT
600 300 900 -Interest 5,000
-hlt.erest@ 12%
-- - - -
-2,100
Pn)fit before Tax 2,400 2,700 ~fit before Tax 35,000
Financial Leverage 1.25 1.11 1.43
Find out:
<EBIT I Profit before Tax)
(i) Using the concept to financial leverage, by what percentage will the taxable income
SihuzlwnB: increase ifEBIT increases by 6%.
E.Bff f.2,000 ?2,000 r.2,000
(ii) Using the concept o_
f operating leverage, by what percentage will EBIT ind·ease 1f
-Interest@ 12% 600 300 900
there is 10% increase in sales, and
!I'""

~'
1? LIVlflAGI ANALYIII ... ..,... 1Ill
...,
182 BASIC FINANCIAL MANAQIMINT ., .
f .CJMLIA
(iii) Using the conceµt of leveragu, by what percentage will the ta.~ablci incomci incrouci if
the sales increase by 611,. Also verify the rosult.s in view of the abovo n,uros. 1
.-m,w 2, , j : :111'-12 ,- z,&Sifi.'iit ;~1~11
Solution: Stolt .,..,,._. ,aoi oflM fol1"111l1t1 ,101,,,..,.,, I, 7~• ('l') or lt1l11 (T)I
Cl) Op,ralJnf ln--,.1.1W1•.. I.ht relatJOl\1hlp betwHn 111111 lt vt l tlnd J~J,19,
(i} Degree of Financial Leverage : (U) Ftnanalal ljtvtra,t d1penda upon I.ht ol)lr1Un1 ltvetAM•·
FL = EBIT/Profit before Tu= 40,000/35,000 um DMdtnd OIi Pref. ah&rtl I• • tut.or or optr11ilnr ltvttll••
= 1.143 CM Optrat.in, lev_,. may be denned u OonlllbwUon + EP8.
(II) Finanoial levva,t depend, 11pon the ftxed ftrw11i1I oha,111,
If EBIT increases by 6'i>, the taxable income will increase by 1.143 x 6 • 6.86111 ~nd it (Ill) FavOW'ablt ftnaalll i.v.rap Md &radln, cin equity 111 1am1,
may be verified as follows :
MO Combined 1,...... •tabll•h• th• r1l1Uon,hlp blitWfffl op1raUn1 l•ver•r• l tld nn. Mlil
EBIT (after 6'1, increase) f42,400 ltvtNP
(c,lll) Fl.nanoial ltvara,t II alwa,y1 beMtlalal to the firm.
-Interest 5,000
(ts) Total rilk ot •arm.II cletar'lmMd by IJul aombJned •lftoi or oper1tJnr and tlnnlldid l#V•r•«••·
Profit before Tax 37,400 (I) Combinad ltvertp helpa in anal)'linl the tlfect of alw\11 In 1111111 J.wel on Lh• J!,l'tJ or I.ii• nnti,
(M,&Ufrw : ('1 F, (IO F, UU) F, (11/JI', Ml', (111) T, (1111) JI', (ullJ) Ji', CJ.r) 1', 1.r) 11
Increase in taxable income is f 2,400 i.e., 6.86'1 off 35,000.

(ii) Degree of Operating Leverage :

OL = Contribution/EBIT = 1,40,000/40,000 = 3.50 1, Write llhori aot. on :
(11) Fixtd P'inuclal 00tt.1. (b) ComblMd .L.vsrlK!i,
If sale increases by 10%, the EBIT will increase by 3.150 x 10 = 35% and it may be verified
as follows: 2. What do you mean by lever.,.? Why 11 lncreuln, indlutlv• of Jru:11u lni ri•k'I
i.v.,.-,,
Sales (after 10% increase) 3. Diff'erentiate betw11n tht bull.nel1 n•k llod llJMLneln, rl•k tlrm. How Uli CM}' m.uund
or•
f 2,20,000 by tho liver-,. ?
- Variable Expenses @ 30% 66,000 4. Di1tln,uilh bet\'l'fffl o~•tinr 1-vtra,, 11M nnandal i.v.,.,,,How the two lflVlft'IP, W), Ve
Contribution mea1W'td? (IJ.Com., fj.{J,, .ZOJ(lj
1,54,000
Fixed cost 6. Explain the concept of nnancial ltvtTa,a. Examln• Lh• .Impact of nnanc:lal L.vor•ia on the
1,00,000 EPS. Dou tbt bancial levera,1 alw1y1 Iner..,_ Lht EPS?
EBIT 54,000 6. What ii !l(lmblnld ltvtrlit? ExamiM I1M li,n.lncanc, In tllllilldal plaMfog ()( a t1rm.
Increase in EBIT is f 14,000 i.e., 35% off 40,000. 7. Diff'1r1nti1te b1twHn 'Bu.in111 Ri1k' and 'PinandAJ W.k' outllnJn, tho rn/iJn a1uu <n tr.Uh
type olriak. UJ,Com., /J,[J,, 20111
(iii) Degree of Combined Leverage 8. Explain briefly the concept o( dnanc:14J lov11r1110. Dln'crontiate bltwMn the ~wo leV11r•1••
(B,Com., D.lJ,, 20131
CL = Contribution/Profit before Tax =1,40,000/35,000 =4 9. Ditferentiate bltwNn bU1U1N1 riak and 1lnandal riak. a.nd how art tJUiH raauw-ad?
If sale increases by 6%, the Profit before Tax will increase by 4 x 6 = 24% and it may be CB.Com,, D,U,, 20UJ
verified as follows : 10. What are the variou. fac:ton which affect bulinaa riak a.nd tinandJiJ riak Orm? Diffitrtndau
or
thMe two tYPN alriab. ID.Com,, D,U,, 10161
Sales (after 6 % increase) f 2,12,000 lL Deane 'levera,_., What an dil!'erent t)'J)N olln11r1iN? Explain. IS.Com., D,lJ,, 20JCI
- Variable Expenses @ 30% 63,600
Contribution 1,48,400
1m11nw--=---~~,·------
; ;; ~,--~ ____··--
,_,. ___·t#s»i.:~
-Fixed cost P8,l. The foll~ fl,ur111 relate to two compani• :
1,00,000
EBIT (la " Jae.,)
48,400
-Interest AL&d. BLtd.
5,000 Salea 760
Profit before Tax 1,000
43,400 - Variable Coa~ 300
Increase in Profit before Tax is f 8,400 i.e., 24% off 35,000. Contribution 460 700
 184
B'ASIC FINANCIAL MANAGEMENT

- Fixed costs 225

EBIT 225. 300
-Interest 75
Profit before Tax 150 200
Yon are required to: ·

(i) Calculate the operating, financial and combined leverages for the two companies; and
fii) Co=ent on the relative risk position of them.
f.Answer : OL =2 and 2.33; FL =1.5 and 1.5 and CL =3 and 3.51
P6.2. A firm has sales of f 20,00,000, Variafile costs off 14,00,000 and Fixed costs off 4,00,000
inclusive of interest off 1,00,000.
(i) Calculate its operating, financial and combined leverages.
(ii) If the firm decides to double its EBJ.T, how much of a rise in sales would be needed on a
percentage basis? ·
fAns:wer : Operating leverage is 2. So, 50% ·increase in sales is required for 100% increase in
EBfF.J
P6.3. The capital strttcture of the Progressive Corporation consists of an ordinary share capital of
f 10,00,000 (shares off 100 per value} and r 10,00,000 of 10% Debentures. Sales increased by
20% from 1,00,000 units to 1,20,000 uni-ts, the selling price is r 10 per unit, variable costs
amount to r 6 per unit and fixed expenses amount to f 2,00,000. The income-tax rate is
llSSllmed to be 50%.
You are required to calculate the following :
(i) The percentage increase in earnings per share.
(ii} The degree of financial leverage at 1,00,000 units and 1,20,000 11Dits.
(iii} The degree of operating leverage at 1,00,000 units and 1,29,000 units.
rAnswer: (i) 80%, (ii) 2 and 1.56 and (iii) ~and-1.71.J -
P6.4. XYZ Ltd has an average selling price off 10 per unit. Its variable unit costs are r 7, and ftxed
cos.ts amount to r 1,70,000. It finances all its assets by equity funds. It pays 5041 tax on its
i.oeome. ABC Ltd is iden·uca1 to X¥Z Ltd. except in respect of the pattern of-financing. The
latter finances its assets 50% by equity and 50% by debt, the interest on which amounts to
r 20,000. Determine the degree of operating, finani:iai and combined leverages at r 7_.00,000
sales for both the firms. and interpret the results.
(Answer : Combined leyerage of the two firms are 5.25- and 10.5}
P6.5. The foltowing is the income statement ofXYZ Ltd. :
Sales f 50 lacs.
- Variable cost l&iacs
- Fbi:ed-cost 20 laca
_,____
EBJT 20-lacs
-Interest
Profit before Tax 16lacs
T:u:@4~ 6 lacs
Prout after Tax 9Jacs