ACHARYA INSTITUTE OF TECHNOLOGY

DEPARTMENT OF MBA

CAPITAL STRUCTURE AND LEVERAGES

1.XYZ Ltd is an established company which requires more funds of Rs.30,00,000 for its expansion
scheme, apart from the original equity capital of Rs.30,00,000 at Rs.100 per share.

The Director has the following options to raise the additional funds:

i)All equity shares

ii) Rs.10,00,000 in equity shares and balance in 8% debentures

iii) All in the form of debentures carrying an interest rate of 8%

iv) Rs.10,00,000 in 12% preference shares and the balance in equity shares

The expected EBIT is Rs.8,00,000 and the tax rate applicable is 50%. Advise the company by analyzing
the options. (June 2013/10MBA23)&(Dec 2012/10MBA23)

2.Calculate operating leverage, financial leverage and combined leverage under situation A and B and
financial plan1 and 2. From the following information relating to XYZ Ltd. (June 2013/10MBA23)

Particulars Amount

Installed capacity(units) 1200

Actual production and sales(units) 800

Selling price per unit(Rs) 15

Variable cost per unit(Rs) 10

Fixed cost in situation A(Rs) 1000

Fixed cost in situation B(Rs) 2000

Financing plans:

particulars 1 2

Equity 5000 7500

Debt 5000 2500

Cost of debt 12% 12%

liabilities Rs Assets Rs

Equity capital(Rs10 per share) 90,000 Net fixed assets 2,25,000

10% long term debt 1,20,000 Current assets 75,000

Retained earnings 30,000

Current liabilities 60,000

Total 3,00,000 3,00,000

The company’s total asset turnover ratio is 3, its fixed operating cost is Rs.1,50,000 and its variable
operating cost is 50% of sales. The income tax rate is 50%. You are required to :

i) Calculate the different types of leverages for the company ii) Determine the likely level of EBIT if EPS is
Rs.2 (Dec 2012/10MBA23)

4.The selected financial data for X, Y and Z companies for the year ended March 31 are as follows:

Particulars X Y Z

Variable expenses as a percentage of sales 66.67 75 50

Increased expenses(Rs) 200 300 1000

DOL 5 6 2

DFL 3 4 2

Income tax rate 0.35 0.35 0.35

Prepare income statements for X,Y and Z companies. (June 2012/10MBA23)

5.Oriental Ltd has currently an ordinary share capital of Rs.25 lakhs, consisting of 25,000 shares of
Rs,100 each. The management is planning to raise another Rs.20 lakhs to finance major expansion
programme, through one of four possible financial plans,

i) Entirely through ordinary shares ii) Rs.10 lakhs through ordinary shares and Rs.10 lakhs in 8% long
term loan iii) Rs.5 lakhs through ordinary shares and Rs.15 lakhs through 9% loan(LT)

iv) Rs.10 lakhs through ordinary shares and Rs.10 lakhs through preference shares with 5% dividend.
 The company’s expected earnings before interest and taxes(EBIT) will be Rs.8 lakhs. Assuming a
corporate tax rate of 50%, determine the EPS in each alternative and comment, which alternative is best
and why? (June 2012/10MBA23) &(June200908MBA23)

6.The data relating to two companies are as given below:

Company A Company B

Capital Rs.6,00,000 Rs.3,50,000

12% Debentures 4,00,000 6,50,000

Output (units) per annum 60,000 15,000

Selling price per unit 30 250

Fixed costs per annum 7,00,000 14,00,000

Variable costs per unit 10 75

You are required to calculate the operating leverage, financial leverage and combined leverage of two
companies. (June 2012/10MBA23)

7.A company has sales of Rs.5,00,000, variable cost of Rs.3,00,000, fixed cost of Rs.1,00,000 and long
term loans of Rs.4,00,000 at 10% rate of interest. Calculate the operating, financial and combined
leverage. (Dec 2011/10MBA23)

8.The following figures relate to 2 companies:

particulars PLtd (Rs in lakhs) Q Ltd (Rs in lakhs)

Sales 500 1000

Variable cost 200 300

Contribution 300 700

Fixed assets 150 400

EBIT 150 300

Interest 50 100

Profit before tax 100 200

You are required to:

1. Calculate the operating, financial and combined leverages for the two companies.

2. Comment on the relative risk position of them. (Jan 2015/10MBA23)

Sales 5,00,000 units at Rs.10 per unit; variable cost per unit at Rs.3.50 ; fixed charges Rs.5,00,000;
interest charges Rs.20,000 (Jan 2015/10MBA23

10.The selected financial data of A,B and C companies for the year ended 31-12-2010 are as follows:

Particulars A B C

Variable expenses as % of sales 66.66 75 50

Interest expenses Rs 200 Rs300 Rs1000

Degree of operating leverage 5:1 6:1 2:1

Degree of financial leverage 3:1 4:1 2:1

Income tax rate 0.50 0.50 0.50

Prepare income statement for A, B and C companies. (Jan 2015/10MBA23)

11.Anand Ltd is in need of Rs.50,00,000 for its expansion programme apart from the original equity
capital of Rs.50,00,000 of Rs.100 each. The directors of the company have the following plan for
expansion:

i) The entire amount of additional capital to be raised through issue of equity shares of Rs.100 each

ii) Rs.20,00,000 in equity shares and balance amount in 10 per cent debentures

iii) Issue 10 percent debentures

iv) Rs.20,00,000 in 12 percent preference shares and balance in equity.

The expected EBIT is Rs.15,00,000. The tax rate applicable to the company is 50%. Analyze the options
and select the best option. (Jan 2015/12MBA25)

12.A firm’s sales, variable costs and fixed costs amount to Rs.75,00,000, Rs.42,00,000 and Rs.6,00,000
respectively. It has borrowed Rs.45,00,000 at 9% and its equity capital totals Rs.55,00,000.

i) What is the firm’s ROI? ii) Does it have favourable financial leverage ?

iii) If the firm belongs to an industry whose asset turnover ratio is 3, does it have a high or low asset
leverage?

iv) What are the operating, financial and combined leverages of the firm? (Jan 2015/12MBA25)
13.The following is s the balance sheet of Varun Ltd as on 31-03-2008:

Liabilities Amount Assets Amount

Equity capital 1,80,000 Fixed assets 4,50,000

10% Debentures 2,40,000 Current assets 1,50,000

Retained earnings 60,000

Current liabilities 1,20,000

Total 6,00,000 6,00,000

The company’s total assets turnover ratio is 2.5 times. The fixed operating costs are Rs.2,00,000.
Variable cost ratio is 40%. Income tax is 50%. The equity shares are issued at Rs.10 per share. You are
required to: i) Calculate leverages ii) Determine the likely level of EBIT if EPS is Rs.6(Dec 2010/08MBA23)

14.A company’s capital structure consists of the following:

Equity shares of Rs.100 each Rs.20 lakhs

Retained earnings Rs.10 lakhs

9% preference shares Rs.12 lakhs

7% debentures Rs.8 lakhs

--------------------

50,00,000

The company earns 12% on its capital. The income-tax rate is 50%. The company requires a sum of
Rs.25 lakh to finance its expansion programme for which the following alternatives are available to it:

i) Issue of 20,000 equity shares at a premium of Rs.25 per share.

ii) Issue of 10% preference shares and iii) Issue of 8% debentures

Which of the three financing alternatives would you recommend and why? (Dec 2010/08MBA23)

15.Calculate the degree of operating leverage, financial leverage and combined leverages for the
following firms: (Jan.2017/12MBA25)

P Q R

Output(units) 3,00,000 75,000 5,00,000

Fixed cost(Rs) 3,50,000 7,00,000 75,000

Interest expenses(Rs) 25,000 40,000 NIL

Unit selling price(Rs) 3 25 0.50

16.The following is the balance sheet of V Ltd as on 31/03/2014. (June 2014/12MBA25)

Liabilities Amount(Rs) Assets Amount(Rs)

Equity capital(Rs.10 per share 1,80,000 Fixed assets 4,50,000

10% Retained earnings 2,40,000 Current assets 1,50,000

Retained earnings 60,000

Current liabilities 1,20,000

Total 6,00,000 6,00,000

The company’s total assets turnover is 2.5 times. The fixed operating costs are Rs.2 lakhs. Variable
operating cost ratio is 40%. Income tax rate is 50%. Calculate three leverages.

17.A firm has capital structure exclusively comprising of ordinary shares amounting to Rs.10,00,000. The
firm now wishes to raise additional Rs.10,00,000 for expansion. The firm has four alternative plans:

Plan A: It can raise the entire amount in the form of equity capital.

Plan B: It can raise 50% as equity capital and 50% as 5% debentures.

Plan C: It can raise entire amount as 6% debentures.

Plan D: It can raise 50% as equity capital and 50% as 5% preference capital.

Further assume that the existing are Rs.1,20,000 and the tax rate is 35%, out standing ordinary shares
are 10,000 and the market price per share is Rs.100 under all the four alternatives. Which financing plan
should the firm select? (June 2013/08MBA23)

18. Calculate the financial and operating leverage, under situations A and B, financial Plan I and II
respectively, from the following relating to the operations and capital structure of ABC Ltd.

Production and sales 800 units , Selling price per unit Rs.20
 Variable cost per unit Rs.15, Fixed costs: Situation A -800 Situation B: Rs.1500

Capital structure: Financial Plan I Financial Plan II

Equity Rs.5000 7000

Debt Rs.5000 2000

Cost of debt@ 12% (June 2010/08MBA23)

19.Calcualte operating leverage, financial leverage and combined leverage from the following data:

Sales(1,00,000 units) Rs.2,00,000

Variable cost per unit Rs.0.70

Fixed cost Rs.65,000

Interest charges Rs.15,000