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Leverage: Prepared By:-Priyanka Gohil
Leverage: Prepared By:-Priyanka Gohil
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Leverage
Prepared by:-
Priyanka Gohil
Leverage
“The employment of an asset or source of funds
for which the firm has to pay a fixed cost or fixed
return may be termed as leverage.”
Types of Leverage
3. Combined Leverage
The
1. Operating Leverage Organization 2.Financial Leverage
1.OPERATING LEVERAGE
Operating leverage arises from fixed operating
costs (fixed costs other than financing costs), such
as depreciation, salaries, advertising expenditure.
1. % change in EBIT
% change in sales
2. Q(S-V)
Q(S-V)-F
Where,
Q= No. of units sold
S= Unit S.P.
V= Unit V.C.
F= Fixed cost for the period
3. Contribution or (S-V)
Operating profit or EBIT
EX. From the following selected operating data,
determine the degree of operating leverage. Which
company has the greater amount of business risk?
A Ltd. B Ltd.
Sales 25,00,000 30,00,000
Fixed costs 7,50,000 15,00,000
Variable expenses as a percentage of sales are 50
percent for firm A and 25 percent for firm B.
EX. Find out operating leverage from the
following data:
Sales: Rs. 50,000
Variable costs 60 percent of sales
Fixed costs: Rs. 12,000
EX. Calculate the DOL of Sharma enterprises.
Quantity produced and sold - 2000 units
Variable cost - Rs. 2
00 per unit
Selling price per unit - Rs. 300 per unit
Fixed expenses - Rs. 20,000
EX.
Sales in units 2000
Sales revenue Rs. 20000
Variable cost 10000
Contribution 10000
Fixed cost 10000
EBIT 10000
EX. Brightways ltd. The management had developed the
following income statement based on an expected sales
volume of 1,00,000 units:
Sales (1,00,000 units at Rs. 8) 8,00,000
Less: Var. costs (1,00,000 at Rs.4 ) 4,00,000
Contribution 4,00,000
Less: Fixed costs 2,80,000
EBIT 1,20,000
2.Financial Leverage
• Financial Leverage arises from the use of
fixed cost financing.
• Financial leverage measures the degree of the
use of debt and other fixed-cost sources of fund to
finance the assets the firm has acquired. It can be
said that higher the proportion of debt in the
capital structure, the higher is the financial
leverage and vice-versa.
1. DFL= % change in EPS
% change in EBIT
2. DFL= Q(S-V)-F
Q(S-V)-F- INT
3. When Preference capital is not used
DFL = EBIT
EBIT-I
When preference capital is used
DFL = EBIT
[EBIT-I-(Dp/ (1-t)]
Dp= preference dividend
t= tax rate
EX. The operating and cost data of ABC Ltd. Are:
Sales 20,00,000
Variable costs 14,00,000
Fixed costs 4,00,000(Including 15%
int. on Rs. 10,00,000)
EX. Following are the balance sheets of 2 firms A and B
Balanc Balanc
e sheet e sheet
of A of B
Equity 2,00,0 Assets 2,00,0 Equity 80,000 Assets 2,00,0
00 00 00
Capital Capital
Debt 1,20,0
@ 00
15%
Total 2,00,0 Total 2,00,0 Total 2,00,0 Total 2,00,0
00 00 00 00
Both the companies earn an income before interest
and tax of Rs. 80,000. Calculate the DFL and
interpret the result thereof.
EX. ABC Ltd. Has an EBIT of Rs. 7,00,000 at 7,000 units production
and sales. The capital structure is as follows:
Capital Structure Amount Rs.
7,00,000 equity shares of Rs. 10 70,00,000
each
12% Debenture 5,00,000
10% Preference shares of Rs. 100 5,00,000
each
Total 80,00,000
Corporate tax rate may be taken at 40%
Combined Leverage
1. Percentage change in EPS/Percentage
change in Sales
2. DCL= DOL* DOF
3. DCL= C (S-V) * EBIT = Contribution
EBIT EBIT-I EBIT-I
EX. A firm’s sales, variable costs and fixed cost
amount to Rs. 75,00,000,42,00,000and Rs.
6,00,000 respectively. It has borrowed Rs.
45,00,000 at 9 percent . Calculate
DOL,DOF,DOC.
EX. Calculate (a) the operating leverage, (b) financial leverage and (c)
Combined leverage from the following data under situation I and II and
financial plans, A and B.
Installed capacity, 4000 units
Actual production and sales, 75 percent of the capacity
Selling price, Rs. 30 per unit
Variable cost, Rs. 15 per unit
Fixed cost:
Under situation I, Rs. 15,000
Under situation II, Rs. 20,000
Capital structure:
Financial Plan
A B
Equity 10,000 15,000
Debt (0.20 interest) 10,000 5,000
20,000 20,000
EX. Calculate Operating leverage, financial leverage and combined
leverage under situation A,B,C and financial plans 1,2, and 3
respectively from the following information relating to the operation
and capital structure of X, Y, Z Ltd. Also find out The combination of
operating and financilal leverage which give the highest value and the
least value.
Installed capacity (units) 1,200
Actual production and sales (units) 800
Selling price per unit (Rs.) 15
Variable cost per unit(Rs.) 10
Fixed costs (Rs.) Situation A 1,000
Situation B 2,000
Situation C 3,000
Capital structure:
Financial plan
1 2 3
Equity 5,000 7,500 2,500
Debt 5,000 2,500 7,500
Cost of debt (for all plans) 12 percent
EX. Calculate operating, financial and combined leverages under
situation when fixed costs are,
(a) Rs. 5,000
(b) Rs.10,000 and financial plans 1 and 2, respectively, from the
following information pertaining to the operation and capital structure
of XYZ Ltd.
Sales 60,000
Variable costs as percentage of sales 60
Capital structure
Financial Plans
1 2
Equity 30,000 10,000
10% Debenture 10,000 30,000
EX. A firm has sales of Rs. 20,00,000, Variable
costs of Rs. 14,00,000, fixed costs of Rs. 4,00,000,
and a debt of Rs. 10,00,000 at 10 percent.
Calculate its operating, financial and combined
leverage.
