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Leverages
MBA (Sem II) – Module 2
CA. Pramod Prabhu. S.H.
Operating Leverage:
1. Following data are taken from records of a company:
Installed Capacity
Operating Capacity
Selling Price p.u.
VC p.u.
Fixed Costs:
Situation A
Situation B
Situation C
1,000 Units
800 Units
Rs. 10
Rs. 7
Rs. 800
Rs. 1,200
Rs. 1,500
Calculate DOL, BEP & MOS in each situation.
Financial Leverage:
2. A Ltd has Equity capital of Rs. 5 lacs divided into shares of Rs. 100 each. It
wishes to raise further Rs. 3 lacs for expansion. The following Plans are
available:
a. All Equity Shares
b. Rs. 1 lakh in Equity Shares & Rs. 2 lakh in 10% debentures
c. All debt @ 10%
d. Rs. 1 Lakh in Equity shares & Rs. 2 lakhs in 8% Preference Shares
The Company’s existing EBIT is Rs. 1,50,000. Corporate tax rate is 50%.
Determine the EPS on each Plan & Comment on Implications of FL.
3. Calculate the EPS of X Ltd & Y Ltd assuming
i) 20% before tax rate of return on Assets
ii) 10% before tax rate of return on Assets, based on the following:
Leverages
MBA (Sem II) – Module 2
CA. Pramod Prabhu. S.H.
Particulars
Assets
Debt (12%)
Equity (Shares @ Rs. 10 each)
X Ltd
(Rs. in Lakhs)
200
200
Y Ltd
(Rs. in Lakhs)
200
100
100
Assume a 50% Tax in both cases. Comment on Financial Leverage.
4. XYZ currently has an Equity Capital of Rs. 40 lacs consisting 40000 equity
shares of Rs. 100 each. The management plans to raise another Rs. 30 lakhs
to finance a major expansion through the following means:
i) Entirely through Equity Shares
ii) Rs. 15 lakhs in equity shares of Rs. 100 each & balance in 8% debentures
iii)Rs. 10 lakhs in equity shares of Rs. 100 each & balance through long term
borrowings @ 9% rate of Interest
iv)Rs. 15 lakhs in equity shares of Rs. 100 each & balance through
Preference shares with 5% dividend
The company’s expected EBIT is Rs. 15 lakhs. Assuming Corporate tax rate
to be 50%, determine the EPS & comment on the Financial Leverage that is
authorised under each of the above schemes of financing
Combined (Composite) Leverage:
5. A Company has sales of Rs. 5 lakhs, VC of Rs. 3 lakhs, Fixed Costs of Rs. 1
lakh & Long term loans of Rs. 4 lakhs @ 10% Interest rate. Compute DCL.
Leverages & Risk Analysis:
6. The following figures relate to two companies. You are required to
i) Compute the Operating, Financial & Combined leverages for the
companies
ii) Comment on their relative risk position
Leverages
MBA (Sem II) – Module 2
CA. Pramod Prabhu. S.H.
Particulars
Sales
Less: Variable Costs
Contribution
Less: Fixed Costs
EBIT
Less: Interest
EBT
P Ltd ( Rs in lacs)
500
(200)
300
(150)
150
(50)
100
Q Ltd (Rs in Lacs)
1000
(300)
700
(400)
300
(100)
200
Practice Questions:
7. A firm has sales of Rs. 20 lacs, VC of Rs. 14 lacs, Fixed Costs of Rs. 4 lacs and
debt @ 10% interest rate – Rs. 10 lacs. Find DOL, DFL & DCL. If the firm
wants to double its EBIT, how much rise in sales would be required on a %
basis?
8.
Leverages
MBA (Sem II) – Module 2
CA. Pramod Prabhu. S.H.
9. A firm has Sales of Rs. 75 lacs. Its Variable Costs & Fixed Costs are Rs. 42
lacs & Rs. 6 lacs respectively. It has a debt of Rs. 45 lacs @ 9% Interest &
equity of Rs. 55 lacs.
i) What is the Firm’s ROI
ii) Does the firm have a favorable FL?
iii)Calculate DOL,DFL & DCL
iv) If Sales drop to Rs. 50 lacs, What is the new EBIT?
v) At what level does EBT of the firm equals Zero.
10. The Capital Structure of ABC Ltd consists of Ordinary Share Capital of Rs. 5
lacs (@ Rs. 100 per Share) & 10% debentures of Rs. 100 each – Rs. 5 lacs.
Sales increased from 50,000 to 60,000 units, the Selling Price being Rs. 12
p.u, VC amounting to Rs. 8 p.u & Fixed Expenses amounting to Rs. 1 lakh.
The Income tax rate is assumed to be 50%.
1. Calculate the % increase in EPS
2. DFL at 50,000 units & 60,000 units
3. DOL at 50,000 units & 60,000 units
4. Comment on behavior of EPS, OL & FL on increase of sales
11. i) When will a firm be considered as favorably leveraged?
ii) A firm’s DCL is 6 times, while DFL is 3 times. What is the relationship
between Contribution & EBIT?
iii) A firm’s DOL is 4 times, while DCL is 10 times. What is the relationship
between EBIT & EBT?
Leverages
MBA (Sem II) – Module 2
CA. Pramod Prabhu. S.H.
12. Complete the following statement from the given data:
Statement
Data
PAT = 5% of Sales
IT Rate = 50%
DOL = 4 times
Debt Component in Capital – NIL
VC = 3 lakhs
Sales
Less: VC
Contribution
Less: FC
EBIT
Less: Income Tax
PAT
13. From the following information, prepare the Income statement of
Companies A,B & C
Particulars
FL
Interest
OL
VC Ratio
IT Rate
A
3:1
Rs. 200
4:1
66.67%
45%
B
4:1
Rs. 300
5:1
75%
45%
C
2:1
Rs. 1,000
3:1
50%
45%
Leverages
MBA (Sem II) – Module 2
CA. Pramod Prabhu. S.H.
14. The Balance Sheet of Alpha Ltd is given below:
Liabilities
ESC (Rs. 10 each)
10% Long Term Debt
Retained Earnings
Current Liabilities
Rs
90,000
1,20,000
30,000
60,000
TOTAL
3,00,000
Assets
Net FA
Current Assets
Rs
2,25,000
75,000
TOTAL
3,00,000
The Company’s Total Assets Turnover ratio is 3, Fixed Operating Costs – Rs.
1,50,000 & Variable Operating Costs Ratio - 50%. IT Rate – 50%.
i) Calculate the different types of leverages for the Company
ii)Determine the likely level of EBIT, if EPS is a) Re.1 b) Rs. 2 c) 0
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