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Subject: Financial Management

Topic: Leverages By: Questionscastle Academic Team Document Code: CA/IPCC/FM/00015 1. A simplified income statement of Zenith is given below: Zenith Ltd. Income Statement for the year ended 31st Mar 1998 Particulars Sales Variable Cost Fixed Cost EBIT Interest Taxes (30%) Net Income Calculate and interpret the following: (i). Degree of Operating Leverages (ii). Degree of Financial Leverages (iii). Degree of combined leverages 2. A firm has sales of `40 lakhs; Variable Cost of `25 Lakhs; Fixed cost of `6 lakhs; 10% debts of `30 lakhs; and equity capital of `40 lakhs. Calculate operating and financial leverages. 3. Annual Sales of a company is `60,00,000. Sales to variable cost ratio is 150% and fixed cost other than interest is `5,00,000 p.a. Company has 11% debentures of `30,00,000. You are required to calculate the operating, financial and combined leverages of the company. 4. From the following information available for the four companies, calculate: (i) EBIT; (ii) EPS; (iii) Operating leverage; (iv) Financial Leverage. Particulars Selling price/unit (`) Variable cost unit (`) Quantity (Nos.) Fixed Cost (`) Interest (`) Tax Rate (%) No. of equity shares P 15 10 20,000 30,000 15,000 40 5,000 Q 20 15 25,000 40,000 25,000 40 9,000 R 25 20 30,000 50,000 35,000 40 10,000 S 30 25 40,000 60,000 40,000 40 12,000

` 10,50,000 7,67,000 75,000 2,08,000 1,10,000 29,400 68,600

5. A company operates at a production level of 5,000 units. The contribution is `60 per unit, operating leverage is 6, combined leverage is 24. IF tax rate is 30%, what would be its earnings after tax? 6. Z Ltd. is considering the installation of a new project costing `8,00,000. Expected sales revenue from the project is `90,00,000 and the variable cost are 60% of sales. Expected annual fixed cost other than interest is `10,00,000. Tax rate is 30%. The company wants to

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arrange the funds through issue of 4,00,000 equity shares of `10 each and 12% debentures of `40,00,000. You are required to: (i). Calculate the operating, financial and combined leverages and EPS. (ii). Determine the likely level of EBIT, if EPS is (1) `4, (2) `2, (3) `0. 7. The following summarizes the percentage changes in operating income, percentage changes in revenues, and betas for four pharmaceutical firms. Firm Change in revenue Change in operating income Beta PQR Ltd. 27% 25% 1.00 RST Ltd. 25% 32% 1.15 TUV Ltd. 23% 36% 1.30 WXY Ltd. 21% 40% 1.40 Required: (i). Calculate the degree of operating leverages for each of these firms. Comment also. (ii). Use operating leverages to explain why these firms have different beta. 8. Calculate the operating leverage, financial leverage and combined leverage from the following the data under situation I and II and financial plan A and B: Installed Capacity 4,000 units Actual production and sales 75% of capacity Selling price `30 per unit Variable Cost `15 per unit Fixed Cost: Under Situation I `15,000 Under Situation II `20,000 Financial Plan A B ` ` 10,000 15,000 10,000 5,000 20,000 20,000

Equity Debt (Rate 20%)

9. X ltd. details are as under: Sales (@ 100 per unit) `24,00,000 Variable cost 50% Fixed Cost `10,00,000 It has borrowed `10,00,000 @ 10% p.a. and its equity share capital is `10,00,000 (`100 each). The company is in a tax bracket of 50%. Calculate: Operating Leverage Financial Leverage Combined Leverage Return on Equity If the sales increased by `6,00,000; what will be the new EBIT? 10. (i) You are required to calculate the operating leverage from the following data: Sales `50,000 Variable Cost 60% Fixed Cost `12,000 (ii) You are required to calculate the financial leverage from the following data: Net Worth `25,00,000 Questionscastle.com Page 2

Debt/Equity Interest Rate Operating profit

3:1 12% `20,00,000

11. The capital structure of the progressive corporation consist of an ordinary share capital of `10,000,000 (shares of `100 par value) and `10,00,000 of 10% debentures. Sales increased by 20% from 1,00,000 units to 1,20,000 units, the selling price is `10 per unit; variable cost amts. to `6 per unit and fixed expenses amt to `2,00,000. The income tax rate is assumed to be 50%. You are required to calculate the following: (i). The percentage increase in earnings per share. (ii). The degree of financial leverage at 1,00,000 units and at 1,20,000 units. (iii). The degree of operating leverage at 1,00,000 units and at 1,20,000 units. Comment on the behavior of operating and financial leverages in relation to increase in production from 1,00,000 units to 1,20,000 units. 12. The data relating to two companies are given below: Company A `6,00,000 Equity Capital 12% Debentures `4,00,000 Output (units) per annum 60,000 Selling price/unit `30 Fixed Cost per annum `7,00,000 Variable Cost per unit `10

Company B `3,50,000 `6,50,000 15,000 `250 `14,00,000 `75

You are required to calculate the operating leverage, financial leverage and combined leverage of two companies. 13. ABC ltd. has an average cost of debt @ 10% and tax rate is 40%. The financial leverage ratio for the company is 0.60. Calculate return on equity if its return on investment is 20%. 14. The following information is available from AMD Ltd. PBDIT `830 Cr Depreciation `6 cr Effective Tax rate 30% EPS `4 Book Value `30 per share Number of outstanding shares 33 Cr D/E ratio 1.5:1 Find: (i). Degree of financial leverage (ii). Financial Break even point 15. You are the Finance Manager in Big Pen Ltd. The degree of operating leverage of your company is 5.0. The degree of financial leverage of your company is 3.0. Your managing director has found that the degree of operating leverage and the degree of financial leverage of your competitor Small Pen Ltd. are 6.0 and 4.0 respectively. In his opinion the Small Pen Ltd. is better than Big Pen Ltd. because of higher value of degree of leverages. Do you agree with the opinion of your MD? Give reasons.

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