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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
Contributi on 15,00,000
Operating leverage = = = 1.67
EBIT 9,00,000
EBIT 9,00,000
Financial leverage = = = 1.50
EBT 6,00,000

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

Particulars Company ‘A’ Company ‘B’

a. Sales Volume (units) 60,000 15,000
b. S.P / unit 30 250
c. Less: V.C / unit 10 75
d. Contribution / unit (b-c) 20 175
e. Total Contribution (a x d) 12,00,000 26,25,000
f. Less: Fixed Cost 7,00,000 14,00,000
g. EBIT (e-f) 5,00,000 12,25,000
h. Less: Interest 12% Debt 48,000 78,000
i. EBT (g-h) 4,52,000 11,47,000

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Contributi on 12,00,000 26,25,000
j. DOL =
EBIT 5,00,000 12,25,000
= 2.4 = 2.14
EBIT 5,00,000 12,25,000
k. DFL =
EBT 4,52,000 11,47,000
= 1.11 = 1.07
l. DCL = DOL X DFL 2.4 x 1.11 = 2.664 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):
P Q R
Output (in units) 2,50,000 1,25,000 7,50,000
Selling Price (per unit) 7.50 7 10
Sales Revenues 18,75,000 8,75,000 75,00,000
Less: Variable Cost 12,50,000 2,50,000 56,25,000
Contribution Margin 6,25,000 6,25,000 18,75,000
Less: Fixed Cost 5,00,000 2,50,000 10,00,000
EBIT 1,25,000 3,75,000 8,75,000
Less: Interest Expense 75,000 25,000 -
EBT 50,000 3,50,000 8,75,000
Contributi on
DOL = 5x 1.67 x 2.14 x
EBIT
EBIT
DFL = 2.5 x 1.07 x -
EBT
DCL = DOL x DFL 12.5 x 1.79 x 2.14 x
Aggressive Moderate Moderate Policy with no
Comment
Policy Policy financial leverage

Problem No. 5
Income Statement (Backward Calculation)

Particulars Firm A Firm B Firm C

Sale revenue 3,600 8,000 12,000
Less: Variable Cost (2/3) 2,400 (3/4) 6,000 (1/2) 6,000
Contribution (1/3) 1,200 (1/4) 2,000 (1/2) 6,000
Less: Fixed Cost 900 1,600 4,000
EBIT 300 400 2,000
Less: Interest 200 300 1,000
EBT 100 100 1,000
Less: Tax @ 45% 45 45 450
EAT 55 55 550
Contribution
Degree of Operating Leverage = 4 5 3
EBIT
EBIT
Degree of Financial Leverage = 3 4 2
EBT

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 Ph: 98851 25025/26 www.mastermindsindia.com
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 XM
A B A B
Situation
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
Less: Interest 4,800 4,800 1,200 1,200
Earnings before tax (EBT) 35,200 30,200 38,800 33,800
Contributi on 60,000 60,000 60,000 60,000
Operating Leverage =
EBIT 40,000 35,000 40,000 35,000
= 1.5 = 1.71 = 1.5 = 1.71
EBIT 40,000 35,000 40,000 35,000
Financial Leverage =
EBT 35,200 30,200 38,800 33,800
= 1.14 = 1.16 = 1.03 = 1.04

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 Amount (Rs.)

Sales revenue 6,00,000
Less: Variable Cost ( 6,00,000 X 40%) 2,40,000
Contribution 3,60,000
Less: Fixed Cost 1,00,000
EBIT 2,60,000
Less: Interest (80,000 X 10%) 8,000
EBT 2,52,000
Less: Tax @ 50% 1,26,000
EAT / EAESH 1,26,000
6,000
No. of Equity Shares 6,000 Shares
10
 EAESH 
EPS   21
 No.of Shares 

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Step 3: Calculation of Leverages
Contributi on 3,60,000
Degree of Operating Leverage = = = 1.38
EBIT 2,60,000
EBIT 2,60,000
Degree of Financial Leverage = = = 1.03
EBT 2,52,000
Degree of Combined Leverage = 1.42

Problem No. 8
a)

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 Amount (Rs.)
Sales revenue 6,00,000
Less: Variable Cost ( 6,00,000 X 40%) 2,40,000
Contribution 3,60,000
Less: Fixed Cost 1,00,000
EBIT 2,60,000
Less: Interest (80,000 X 10%) 8,000
EBT 2,52,000
Less: Tax @ 35% 88,200
EAT / EAESH 1,63,800
6,000
No. of Equity Shares 6,000 Shares
10
 EAESH 
EPS   27.3
 No.of Shares 

Step 3: Calculation of Leverages:

Contributi on 3,60,000
Degree of Operating Leverage = = = 1.38
EBIT 2,60,000
EBIT 2,60,000
Degree of Financial Leverage = = = 1.031
EBT 2,52,000
Degree of Combined Leverage = 1.42

b)

EPS is Rs. 1:
(EBIT − Int ) (1 − t )
We know that EPS =
n
(EBIT − 8,000 ) (1 − 0.35 )
1 =
6,000
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6,000 = (EBIT – 8,000) (0.65)
6,000
EBIT – 8,000 = = 9,230.76
0.65
EBIT = 17,230.76

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

EPS is Rs. 3:
(EBIT − Int ) (1 − t )
We know that EPS =
n
(EBIT − 8,000 ) (1 − 0.35 )
3 =
6,000
18,000
EBIT – 8,000 =
0.65
EBIT = 35,692

EPS is Rs. 0:
(EBIT − Int ) (1 − t )
We know that EPS =
n
(EBIT − 8,000 ) (1 − 0.35 )
0 =
6,000
EBIT = 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
PBT 15,80,000
Less: Tax @ 30% 4,74,000
PAT 11,06,000

PAT 11,06,000
(i) EPS = = = Rs. 11.06
No.of Equity Shares 1,00,000
Contributi on EBIT Contributi on 48,00,000
(ii) DCL = X = = = 3.04
EBIT PBT PBT 15,80,000

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Problem No. 10
Income Statement:

Particulars Rs.
Sales 75,00,000
Less: Variable cost 42,00,000
Contribution (C) 33,00,000
Less: Fixed cost 6,00,000
EBIT 27,00,000
Less: Interest 4,05,000
EBT 22,95,000

EBIT 27,00,000
i) ROI = = = 0.27 = 27%
Capital Employed 1,00,00,000

ii) Interest on Debt = 9%

Since ROI is greater than Interest on Debt it is favorable financial leverage.

Sales 75,00,000
iii) Asset Turnover = = = 0.75
Total assets 1,00,00,000
The firm’s asset turnover ratio is less than the Industry ratio.

Contributi on 33,00,000
iv) Degree of Operating Leverage = = = 1.222
EBIT 27,00,000
EBIT 27,00,000
Degree of Financial Leverage = = = 1.1764
EBT 22,95,000
Degree of Combined Leverage = 1.438
v) Firms Operating Leverage = 1.222
Therefore If 1 % Change in Sales then EBIT change by 1.22%
25,00,000
% Change in sales = = 33.33%
75,00,000
Therefore EBIT will decrease by 40.73% (33.33 X 1.22)
EBIT = Rs. 16,00,290

vi)

Particulars Rs.
Sales (100%) 22,84,091
Less: Variable cost (56%) 12,79,091
Contribution (C) (44%) 10,05,000
Less: Fixed cost 6,00,000
EBIT 4,05,000
Less: Interest 4,05,000
EBT 0

Problem No.11

(i) Net Sales : 30 Crores

EBIT @ 12% on sales : 3.6 crores

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ROI = EBIT = 3.6 x 100 = 20%
Capital Employed 10+2+6

Particulars Rs (In crores)

EBIT 3.60
Interest on debt 0.90
EBT 2.70
Less:tax @40% 1.08
EAT 1.62
Less:Preference Dividend 0.26
Earnings available for Equity Share Holders 1.36
Return of Equity = 1.36/10 x 100 = 13.6%

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

or -2% +1.8% = 1.6%

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 Cost (%) WACC (%)

(i) Equity 10/18 13.60 7.56

(ii) Preference Shares 2/18 13.00 1.44
(iii) Debt 6/18 9.00 3.00
Total 12.00

ii) Computation of Operating Leverage

Given Combined Leverage = 3

Financial Leverage = EBIT/ EBT

= 3.60/2.70

= 1.33

Operating Leverage = Combined Leverage / Financial Leverage

= 3/1.33 = 2.25

THE END

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