6 Leverages

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98851 25025/26
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6. LEVERAGES
SOLUTIONS TO ASSIGNMENT PROBLEMS

Problem No. 1
Calculation of Operating and Financial Leverage:
Rs.
Sales
40,00,000
Less: Variable cost
25,00,000
Contribution (C)
15,00,000
Less: Fixed cost
6,00,000
EBIT
9,00,000
Less: Interest
3,00,000
EBT
6,00,000
Operating leverage =
Contributi on
EBIT
15,00,000
9,00,000
= 1.67
Financial leverage =
EBIT
EBT
9,00,000
6,00,000
= 1.50
Problem No. 2
Contribution
= Sales Variable Cost and
EBIT
= Contribution Fixed Cost
10,00,000
= Contribution 20,00,000
Contribution
= 30,00,000
Operating leverage = C / EBIT = 30,00,000/10,00,000 = 3 times

Financial leverage = EBIT/EBT = 10,00,000/8,00,000
= 1.25 times
Combined leverage = OL x FL = 3 x 1.25
= 3.75 times
Problem No:3
Preparation of Income Statement of Company A & B
a.
b.
c.
d.
e.
f.
g.
h.
i.
Particulars
Sales Volume (units)
S.P / unit
Less: V.C / unit
Contribution / unit (b-c)
Total Contribution (a x d)
Less: Fixed Cost
EBIT (e-f)
Less: Interest 12% Debt
EBT (g-h)
Company A
60,000
30
10
20
12,00,000
7,00,000
5,00,000
48,000
4,52,000
Company B
15,000
250
75
175
26,25,000
14,00,000
12,25,000
78,000
11,47,000
IPCC_34e_F.M_Leverages_Assignment Solutions_______________________40
MASTER MINDS
No.1 for CA/CWA & MEC/CEC

j.
DOL =
k. DFL =
l.
Contributi on
EBIT
12,00,000
5,00,000
26,25,000
12,25,000
= 2.4
= 2.14
5,00,000
4,52,000
EBIT
EBT
12,25,000
11,47,000
= 1.11
2.4 x 1.11 = 2.664
DCL = DOL X DFL
= 1.07
2.4 x 1.07 = 2.568
Problem No. 4
Estimation of Degree of Operating Leverage (DOL), Degree of Financial Leverage (DFL) and
Degree of Combined Leverage (DCL):
Output (in units)
Selling Price (per unit)
Sales Revenues
Less: Variable Cost
Contribution Margin
Less: Fixed Cost
EBIT
Less: Interest Expense
EBT
DOL =
Contributi on
EBIT
EBIT
EBT
DCL = DOL x DFL
DFL =
Comment
P
2,50,000
7.50
18,75,000
12,50,000
6,25,000
5,00,000
1,25,000
75,000
50,000
Q
1,25,000
7
8,75,000
2,50,000
6,25,000
2,50,000
3,75,000
25,000
3,50,000
5x
1.67 x
2.14 x
2.5 x
1.07 x
12.5 x
Aggressive
Policy
1.79 x
Moderate
Policy
2.14 x
Moderate Policy with no
financial leverage
7,50,000
10
75,00,000
56,25,000
18,75,000
10,00,000
8,75,000
8,75,000
Problem No. 5
Income Statement (Backward Calculation)
Particulars
Sale revenue
Less: Variable Cost
Contribution
Less: Fixed Cost
EBIT
Less: Interest
EBT
Less: Tax @ 45%
EAT
Degree of Operating Leverage =
Contribution
EBIT
EBIT
EBT
Degree of Financial Leverage =
Firm A
Firm B
Firm C
3,600
(2/3) 2,400
(1/3) 1,200
900
300
200
100
45
55
8,000
(3/4) 6,000
(1/4) 2,000
1,600
400
300
100
45
55
12,000
(1/2) 6,000
(1/2) 6,000
4,000
2,000
1,000
1,000
450
550
_Assignment Solutions_______________________41
IPCC_34e_F.M_Leverages
Ph:
98851 25025/26
Problem No. 6
Computation of Operating and Financial Leverage

Actual Production and Sales: 60% of 10,000 = 6,000 units
Contribution per unit: Rs. 30 Rs. 20 = Rs. 10
Total Contribution: 6,000 Rs. 10 = Rs. 60,000
Financial Plan
XY
Situation
XM
Rs.
Rs.
Rs.
Rs.
Contribution (C)
60,000
60,000
60,000
60,000
Less: Fixed Cost
20,000
25,000
20,000
25,000
Operating Profit or EBIT
40,000
35,000
40,000
35,000
4,800
4,800
1,200
1,200
35,200
30,200
38,800
33,800
60,000
40,000
= 1.5
60,000
35,000
= 1.71
60,000
40,000
= 1.5
60,000
35,000
= 1.71
40,000
35,200
= 1.14
35,000
30,200
= 1.16
40,000
38,800
= 1.03
35,000
33,800
= 1.04
Less: Interest
Earnings before tax (EBT)
Operating Leverage =
Financial Leverage =
Contributi on
EBIT
EBIT
EBT
Problem No. 7
Step 1: Finding of Sales Revenue
Turnover / sales
Given total Asset turnover ratio =
Total Assets
=3
Sales
=3
2,00,000
Sales
= 6,00,000
Step 2: Profit Statement
Particulars
Sales revenue
Less: Variable Cost ( 6,00,000 X 40%)
Contribution
Less: Fixed Cost
EBIT
Less: Interest (80,000 X 10%)
EBT
Less: Tax @ 50%
EAT / EAESH
No. of Equity Shares
EPS
EAESH
No.of Shares
6,000
10
Amount (Rs.)
6,00,000
2,40,000
3,60,000
1,00,000
2,60,000
8,000
2,52,000
1,26,000
1,26,000
6,000 Shares
21
MASTER MINDS

Step 3: Calculation of Leverages
Degree of Operating Leverage
Degree of Financial Leverage
Degree of Combined Leverage
Contributi on
3,60,000
=
= 1.38
EBIT
2,60,000
2,60,000
EBIT
=
=
= 1.03
EBT
2,52,000
= 1.42
Problem No. 8
a)
Step 1: Finding of Sales Revenue:
Given total Asset turnover ratio
Sales
2,00,000
Sales
Turnover / sales
Total Assets
=3
=3
= 6,00,000
Step 2: Profit Statement:

Particulars
Amount (Rs.)
6,00,000
2,40,000
3,60,000
1,00,000
2,60,000
8,000
2,52,000
88,200
1,63,800
Sales revenue
Less: Variable Cost ( 6,00,000 X 40%)
Contribution
Less: Fixed Cost
EBIT
Less: Interest (80,000 X 10%)
EBT
Less: Tax @ 35%
EAT / EAESH
6,000
10
No. of Equity Shares

EPS
6,000 Shares
EAESH
No.of Shares
27.3
Step 3: Calculation of Leverages:

Degree of Operating Leverage
3,60,000
Contributi on
=
= 1.38
EBIT
2,60,000
EBIT
EBT
= 1.42
2,60,000
= 1.031
2,52,000
b)
EPS is Rs. 1:
We know that EPS
1
(EBIT Int ) (1 t )
n
(EBIT 8,000 ) (1 0.35 )

6,000
Ph:
98851 25025/26
6,000
EBIT 8,000
EBIT
(EBIT 8,000) (0.65)
6,000
= 9,230.76
0.65
17,230.76
If the level of EBIT is 17,231 then EPS will be equal to Rs. 1

EPS is Rs. 3:
We know that EPS
=
3
EBIT 8,000
EBIT
(EBIT Int ) (1 t )
n
(EBIT 8,000 ) (1 0.35 )
6,000
18,000
0.65
35,692
EPS is Rs. 0:
We know that EPS
=
0
EBIT
=
=
(EBIT Int ) (1 t )
n
(EBIT 8,000 ) (1 0.35 )
6,000
8,000
Problem No. 9
Total Assets = Rs. 48,00,000
Total Assets Turnover Ratio = 2.5
Total Sales = 48,00,000 2.5 = Rs. 1,20,00,000
Computation of Profit after Tax (PAT)
Particulars
Amount
Sales
1,20,00,000
Less: Variable Cost ( 60% of Sales Contribution)
72,00,000
Contribution
48,00,000
Less: Fixed Cost (other than Interest)
28,00,000
20,00,000
Less: Interest on Debentures (15% of 28,00,000)
4,20,000
15,80,000
PBT
Less: Tax @ 30%
4,74,000
11,06,000
PAT
(i)
EPS
PAT
No.of Equity Shares
11,06,000
= Rs. 11.06
1,00,000
(ii)
DCL
Contributi on EBIT
X
EBIT
PBT
Contributi on
PBT
48,00,000
=
15,80,000
3.04
MASTER MINDS
Problem No. 10
Income Statement:
Particulars
Rs.
75,00,000
42,00,000
33,00,000
6,00,000
27,00,000
4,05,000
22,95,000
Sales
Less: Variable cost
Contribution (C)
Less: Fixed cost
EBIT
Less: Interest
EBT
i)
ROI
EBIT
Capital Employed
27,00,000
=
1,00,00,000
0.27
27%
ii) Interest on Debt = 9%

Since ROI is greater than Interest on Debt it is favorable financial leverage.
75,00,000
Sales
=
= 0.75
Total assets
1,00,00,000
The firms asset turnover ratio is less than the Industry ratio.
iii) Asset Turnover =
iv) Degree of Operating Leverage
33,00,000
Contributi on
=
= 1.222
EBIT
27,00,000
EBIT
EBT
= 1.438

v) Firms Operating Leverage = 1.222
27,00,000
= 1.1764
22,95,000
Therefore If 1 % Change in Sales then EBIT change by 1.22%
25,00,000
=
75,00,000
% Change in sales =
33.33%
Therefore EBIT will decrease by 40.73% (33.33 X 1.22)

EBIT = Rs. 16,00,290
vi)
Particulars
Sales
Less: Variable cost
Contribution (C)
Less: Fixed cost
EBIT
Less: Interest
EBT
Rs.
22,84,091
12,79,091
10,05,000
6,00,000
4,05,000
4,05,000
0
(100%)
(56%)
(44%)
Problem No.11
(i) Net Sales

EBIT @ 12% on sales
: 30 Crores
: 3.6 crores
Ph:
98851 25025/26
ROI
EBIT
Capital Employed
= 3.6 x 100
10+2+6
Particulars
EBIT
Interest on debt
EBT
Less:tax @40%
EAT
Less:Preference Dividend
Earnings available for Equity Share Holders
Return of Equity = 1.36/10 x 100 = 13.6%
= 20%
Rs (In crores)
3.60
0.90
2.70
1.08
1.62
0.26
1.36
Segments due to presence of Preference Share capital and Borrowing (Debentures)

Segment of ROE due to presence of Preference Share capital: (0.2(1-0.4)-0.13) x 0.2 =-0.002
Segment of ROE due to presence of Debentures
or -2% +1.8% = 1.6%
(0.2(1-0.4)-0.15(1-0.4)) x 0.2 =0.018
Since segment due to presence of Debt/ Preference = {ROI(1-Tax) Rd(1-Tax) } D/E

Or
{ROI(1-Tax) Rp } P/E
The Weighted average cost of capital is as follows
Source
Proportion
(i)
Equity
Cost (%)
WACC (%)
10/18
13.60
7.56
(ii) Preference Shares
2/18
13.00
1.44
(iii) Debt
6/18
9.00
3.00
12.00
Total
ii) Computation of Operating Leverage
Given Combined Leverage
Financial Leverage
=
=
=
=
Operating Leverage
3
EBIT/ EBT
3.60/2.70
1.33
= Combined Leverage / Financial Leverage

= 3/1.33
= 2.25
THE END

6 Leverages

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6 Leverages

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SOLUTIONS TO ASSIGNMENT PROBLEMS

Less: Variable cost

Less: Fixed cost

= Sales Variable Cost and

= Contribution Fixed Cost

Operating leverage = C / EBIT = 30,00,000/10,00,000 = 3 times

Combined leverage = OL x FL = 3 x 1.25

No.1 for CA/CWA & MEC/CEC

DCL = DOL X DFL

Degree of Financial Leverage =

Computation of Operating and Financial Leverage

Less: Fixed Cost

Operating Profit or EBIT

No.1 for CA/CWA & MEC/CEC

Step 2: Profit Statement:

No. of Equity Shares

Step 3: Calculation of Leverages:

Degree of Financial Leverage

Degree of Combined Leverage

(EBIT 8,000 ) (1 0.35 )

(EBIT 8,000) (0.65)

If the level of EBIT is 17,231 then EPS will be equal to Rs. 1

Less: Variable Cost ( 60% of Sales Contribution)

Less: Fixed Cost (other than Interest)

Less: Interest on Debentures (15% of 28,00,000)

No.1 for CA/CWA & MEC/CEC

ii) Interest on Debt = 9%

iii) Asset Turnover =

iv) Degree of Operating Leverage

Degree of Financial Leverage

Degree of Combined Leverage

Therefore If 1 % Change in Sales then EBIT change by 1.22%

Therefore EBIT will decrease by 40.73% (33.33 X 1.22)

(i) Net Sales

Segments due to presence of Preference Share capital and Borrowing (Debentures)

(0.2(1-0.4)-0.15(1-0.4)) x 0.2 =0.018

Since segment due to presence of Debt/ Preference = {ROI(1-Tax) Rd(1-Tax) } D/E

(ii) Preference Shares

= Combined Leverage / Financial Leverage

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