A firm has sales of R5,00,000; variable cost of 3,50,000 and fixed cost of T1,00,000 and a debt of

250,000 at a 10% rate of interest. What is combined

leverage? If the firm wants to double its EBIT.
how much of a rise in sales would be needed on a percentage basis.
CU B.Com., 2006
Solution

Sales 5,00,000
Less: Variable Cost 3,50,000
Contribution (a) 1,50,000
Less: Fixed Cost 1,00,000
EBIT (b) 50,000
Less: Interest 25,000
EBT (c) 25,000
DCL a/c 6

Therelation between sales and EBIT is expressed by DOL So, we first calculate

DOL = Contribution1,50,000/50,000-3
EBIT
Now by definition we know, DOL =
%Changein EBIT
%Change in sales
100
Of 3 - (to have double EBIT, the change is 100
%Change in sales
Or, %change in sales required =
100/3 33.33
Therefore, sales should rise by 5,00,000 x 33.33% = 71,66,667.
[Revised sales =
5,00,000+1,67,667 76,66,6671
Example 15: Zica Ltd providesthe following information
you
Capital structure 12% Debenture 2,00,000; 9% Preference Share Capital 3,00,000 and
4,000 Equity Shares of 7 100 each.
Revenue and operating cost details: Sales 3,000 units 600 p.u.; Variable Operating Cost
p.u. 350; Fixed Operating cost 7 3,20,000.
Corporate Income Tax rate and Dividend Distribution Tax rate may be assumed at 30%
and 10% respectively.
Calculate DOL, DFL and DCL of Zica Ltd. Using the concept of leverage, find the
increase by 10%.
percentage change in EPS when sales [C.u. B.Com. (Hons.) - 2016]
 Solution Statement showing computation of DOL, DFL and DCL
Particulars Amount
Sales [3000x 7 600]
18,00,0000
Less:Variable cost [3,000 x
350] 10,50,000
Contribution
Less
7,50,000
: Fixed operating cost
3,20,000
EBIT
Less
4,30,000
: Interest [12% of 7 2,00,000] 24,000
EBT
4,06,000
Less: Tax 30%
1,21,800
EAT
Less: Preference Dividend
2,84,2000
Dividend [9% of T 3,00,000] = 27,000
Dividend Tax [11% of 7 27,000]
2,7oo 29,700
Earnings to Equity shareholders
2,54,500
DOL = Contribution = 750,000
EBIT 4,30,000 1.74

[I] DFL =
EBIT 4,30,000
1.18
EBT-
4,06,000-1-0.30)
4,06,00029,700

DCL = Contribution 7,50,000

EBT 29,700 2.063
1-t) 4,06,000-030
Here, DCL= 2.063. This means that if the amount of sales
by 2.063%. Thus, when sales increase by 10%o, EPS will be
changes by 1%, EPS will be changed
increased by (10 x
2.063%) or, 20.63%.
 Example 2 From the following information of Trends Ltd. calculate the degree of
Operating Leverage, Financial Leverage and Combined Leverage for each situations A and B
under financial plans I, II and II. Also indicate which of the above plans is most risky and which
one is least-risky.
Production and Sales 1000 units
Selling price per unit 20
Variable cost per unit 15
Fixed cost (Operating):
Situation- A 3,000
Situation- B 4,000
Capital Structure:
Plan
I III.
(
Equity 7,000 5,000 3,000
10% Debt 3,000 5,000 7,000
10,000 10,000 10,000
Solution » [c.u. B.Com. (Hons.)-2006]
Statement showing forComputation of DOL and DFL
Plan-I Plan-II Plan -I
Particulars Situation Situation Situatio
Sales(20 x 1,000) )| 20,000 20,000 20,000 20,000 20,000 20,000
Less: Variable cost (15x1,000) () 15,000 15,000 15,000
Contribution
15,000 15,000 15,000
() 5,000 5,000 5,000 5,000
Less:Fixed Cost 5,000 5,000
3,000 4,000 3,000 4,000
EBIT () 2,000 1,000
3,000 4,000
2,000 1,000 2,000 1,000
Less : Interest
() 300 300 500 500 700
EBT 700
() 1,700 700 1,500
DOL =Contribution] 500 1,300 300
DOL =
EBIT 2:5
J 2-5
2:5 5
EBIT
DFL EBT 1-18 1-43 1-33 2 1-54 3-33
 Determination of Combined Leverage in situation A and B under financial Plan 1, 1I and III

SituationA Situation-B
Particulars
Plan -1 Plan-IIPlan-II Plan 1 Plarn-PlanI
DOL 2-5 2-5 2.5 5 5 5
DFL 1-18 133 1-54 1-43 2 3-33

DCL DOL x DFL 2.95 3-325 3-85 7-15 10 16-65

The situation A under Plan-I indicates minimum risk and the situation B under
Plan-IlI indicates maximum risk.
 Example 12: 8. Anurup Ltd. has Equity shares capital of t 5,00,000 dividend into shares
of100 each. It wishes to raise 7 3,00,000 for expansion-cum-modernisation scheme. The
company plans the following financing alternatives
() By issuing Equity shares of 100 each.
(i) 1,00,000 by issuing Equity shares of T 100 each and 7 2,00,000 through issue of 10%
Debentures.
(iii) By raisingloan at 10% per annum.
(iv)1,00,000by Equity shares of 7 100 each and 2,00,000 by issuing 8% Preference
shares of 100 each.
You are required to suggest the best alternative giving you comment assuming that the
estimated earning before interest and taxes (EBIT) after expansion 1,50,000 and
Corporate rate of tax is 35%. [C.u. B.Com(Hons.)-2013]
Solution STATEMENT SHOWING EPS UNDER VARIOUS FINANCIAL PLANS.

Particulars Alternative Financial Plans

IV
Capital Structure:
Equity shares of 100 each 8,00,000 6,00,000 5,00,0006,00,000
8% Preference shares of 7 100 each 7 2,00,000
10% Debentures 2,00,000
10% Loan 3,00,000
8,00,000 8,00,000 8,00,0008,00,000
 EBIT
1,50,000 1,50,000 1,50,000 1,50,000
Less Interest on Debenture () 20,000
Less: Interest on loan () 30,000
EBT 1,50,000 1,30,000 1,20,000 1,50,000
Less Tax 35% () 52,500 45,500 42,000 52,500
EAT
() 97,500 84,500 78,000 97,500
Less: Preference dividend
16,000
Earning to Equity shareholders
() 97,500 84 500 78,000 81,500
No. of equity shares 8000 6000 5000 6000
EPSEarming to equity shareholders
ES = No. of equity shares 712.19 14.08 15.60| 13.58
Comment : It is clear from the above statement that
earning per share (EPS) is highest in
the case of alternative III. Hence, alternative - Il should be accepted by the company.