O P E R A T IN G , FINANCIALA

ND
C O M B IN E D LEVERAGE

irh
Th #;\?1¥1
resent chapter discusses the
leverage· analysis i.e. a techniqu
~c ter ist ic of alternative cap e to analyze the risk-return
ital structure. It relates to the fina
ncing decision of the firm.

,·N'fRODUCTION
s.1"tal• • n or fi n
trUCture decisio anc·mg dec1••s1on of any company is very impor
~p• ~e cts the sha re~ old er's r~turn
an d ris~. Capital ~tr uc ~e consist tant because it
cfiiedlY ; debt and equ~ty. D: bt 1s a loa s of two type of sources
n capita~ on which fixed rate of int
ananc:quity is ow ne rs cap ita l an erest has to be paid
d ~h ate ver is left after paying the
fjxedfinallcial obligatio~s goes to the fixed interest and other
eqw ty shareholders. Su~pose borrow
. fund then the risk as well as ed funds are more than
the ret urn to the eqw ty sharehold
because the com pan y wil~ hav e to ers will increase. Risk
pay fixed inter_est irrespective of
Nah ttn to the equ ity sha
reh old ers increases because deb the profits earned.
- more use of deb t in the ~apital t is a cheaper source of finance.
structure will reduce the overall More
ing the returns to the eq wt y shareh cost of capital thereby
olders. The cost of capital provides
formulation of firms ass et str uct ure a direct lin k between
and its financial structure•

.2 LEVERAGE
erage refers to the abi lity of the firm
to employ long-term Leverage
having a fixed cos t to enh anc e refers to the ability of
ret urn to the owners.. the ~nn to
uverage analysis is the em plo ym ent employ long-tenn funds
of fixed assets or funds having
company has to pa y f'1xed costs · f' d
'- hich a fixed cost to enhance
u w
i.e. 1xe opera t·mg return to the owners.
and fixed fin anc ial cha rge s an d .
stu dy the ir im pac t on ear nin gs
eholders. These fixed cos ts hav e to available to eqw ty
be incured regardless of the level
indicates the responsiveness of on of activities or profit.
e financial variable (independent
) over the other financial
 .. ___ - · _,--- - Operating F,·nan •
--·- · .-,,- ' Cial
.. . . e<>t / .. llOd Ceo,~ • •
.. _ .. . . r,CIOl t,4onoll8"' , . . • ' / • . i,Uy finanfed lhrou!l1> equity sh oeo -
· · ,.....is ol floO more eunds ,n fixed _assets lil<e :i,
. •· ,ttY iS 1 content m the capital structureare_ capital then •
~ui,dl · t of ll"ore at1d t this will also lead t~ increase in llla~ • ,~d!t1'P, tJ,e tnartcial risk. It IS. related t_o the WiJI be !her~ Will be
) £,oplol"""" rari1'S ,,,.is bU will u,crease the ftxed financ· SOI,, ii,'\ ;!' i,e tftj and ,ontroUable nsk. The financial ris~g decision ; thmtere,, Pno linana.1
vori•ble (d~"':;. the n,red 0":nd more_ deb~rsharehOlders because debt i:,:.1cha, , ,;o1d•b e ] • • can be measured e ~sin~~t and
- p
ants efC. will ~I use of ll"ore ..,ore eartllngs ding to Ezra Solomon 1 -- ll\g
s·rru\ar Y 1n~d to ,.. 'lity _Accor
11

. 1· . ' t.KVeTag •
as~~. ~r;~"' f:6ff - - - • Fmanoal leverage is Used
·al -'-arges as an • d
by ~ l J_anaa1
~erage
and
\ profit. 1 . "rill alsO "" deductab1 · of returtt on total capita 1satton". Th rs flit • [ • ~Cl v• in ex of fina •
1"._~:t~~~!:if ~L~~ ::~uit¥ a;/~=tcosts or de!!e~~~:~ ;e!~~geafunnun:
0
!~ ; ii'f 'f ...een business risk and financial risk nctal risk
SU"'-· if rtf1lrn o :,,...
f 1
decrease J1\ ent of rnore
ef~ o1 _ , . -ge i.• .,..p1~~\,ve1 of th• ftrtn due to higher outside~ 1-j\ .,.d1
ttll? Jdel'S· t{igh~
• ds ••
increase the nsverage is good· In thl: ~ase -~ might be I .Olt:...\ r,/
ce t,e1.•·
gu,WSS Risk
~-------·---+----- Fin11naa1 Risk
share)t<>profit but t:hiS that the }ower le
wants of funds and failing
I ·fi d • m its ob1·ect1· Oos1n,,-,
Ve j'\ ,;;1<re•''ers to the variability in the Fmanci t
t;gh<' ,,,.,.,.
IJO"""''itd- o Po,tunitie5 for tud 'leverage can be c ass• e mto (a) ope,,nn o ' ,ct<d earnings before interest !. eamin a risk refe,s to th
good """'"";:! pu<Po"' of ·:;ed r~verage- . . . g"" f ..,..• .,q> EB!!') due to employment of d gs available to "!Uitye Variability in
inaxiJniS3tion- ge and (c) corn . I leverage in detail, let us discuss th •..A ta"es ( • the assets havmg more fixuedetofinanexnplo_ymentofm"""'funshareholders
__,.;,.! Jevera and finaJ\oa . • k d ft . e tYpe '1"" t.,ndS lll cial v•"' ds
(b) .,..-,,_,...,g oper•tin8 ,,,,., of risks, business '." an nancml risk. V • fllre '.-·fjl<ed costs- dta,ges. <arrying
2. It arises duet the
•Before=--
""'""°', - 'fhere arebe
..,, .,. twdu• to any Of these two risks.
0 •1r- a11a~ t ...,pratillSdu• to the investment decisions by the firm. o financial taken
""""' s 1
..-.
B,ti¢ ral environment factors like
stre'
AND flNAJ'ICIAL ]USI< . "'d g"'~on, 1ec1tnological changes,
sosJNESS f to the relative dispersion r"6 ~-;i~es ~-?:~".---- i,uitless.b.0 n natural calamities etc.
· · ess risk re ers , interest and , s risk ref --~ ltl.,eb ' 3
8 3_..;..-,; Risk: susin' .,...,,,-ted earnings be1oinhre t . the variability of EBIT era lo It co r· d large unavoidable
B""."'u; ) iP the fin!' "'"'.. to all hazards eren tn . , ohaoges lo ......,as a"" 1 by an • It is avoidable.
~~?i!}. Business riski_;Je~ence it is also crralled opresrulatinto~ ~~company operates ITlent 1n,_: i JI IJJlcontrollable. A company generally
is· 4. It is controllable beca • •
"""""' . f the riskbusiness
refers to the· v~ · bility ofany as a eThis
EBoperates. . envll'orunent
. ,-----:,,__
contains f -........, , do not have control • • over facto rs of financing d • • use it IS a direct result
risk- Busine55 virOrunent in which a corndp r to the whole economy Th actors1o11., ....d!On5ible for busmess nsk. finan easions of th finn.
,llfue
0
'""Z.~': p,-J,r c•'l4",,1,"'co:;,;.;. These may be common io ::;,tin81everage arises due to business s. F craJ decision can contr':.t this~ i
:.., .,.y b e ~ to• P -al economic conditioru; that affect all the industries
industrY or related to the. g bour unrest etc. Sometimes busmess nsk arises duet·
I:"'• i .,....-·
•
• •
(Contribution) •
tnanciaJ leverage arises d
• ( ue to financial
..,..is .,.y be_ due to firee/degree of competition, goverrune~t's policy, change :
_,...,, t,d,n<>togtw c!,an~ calamity like earthquake etc. Busmess risk is una.oM "tit
7"" ds1< and ,ts formula
. •
EBIT
•
ts nsk and its formula EBIT) •
• d EBT used as att
I
change in prices or due to na
. .
it 1S not WI
•thin the control of the comp ·
any As mentioned above, it is also called
[Contribution] • •
operating I& ~;:;~~~;;:~~~~---1______________
"'• ,..i as an index of bUSllless nsk. "' ex of 6nancia! risk.
_j
n,, -wa "' c,kulate operating leverage EBIT ts used as an tndex of b...,_;i l4 oP£RA.TING LEVERAGE ( OL)
[ll'erage related to the operations of the business 15 • all
th ,prating leverage. ff the cost structure of the firm ed r ~ - • - • • ..
fi,urncUll Risk: Financial _risk_is a direct result of . e. ~ir11:'s f Fina~ci~I risk re;rs tll~ts, the operating leverage is said to exist F~onsedists of abilityto'!e~ is U:- &m's '.
financing decision. Financial risk refers to the ~~nabil~ty m variability in eamlngsoflhelo ,L.cost • d • ix costs •WNoperalingCOSIS i
IP: structure ts use to magnify the effect of chan 10 • ID magnify the effact d c1a1ges
earnings of the equity shareholders and the additional nsk of • shareholders and the
ll!s M the pattern of earnings of a firm. Fixed les in sales on its esn: '.
insolvency bome by the equity shareholders ~ue ~o the us~ of t risk of insolvency borne bJ . . (increase/decrease) with th ch . costs o not--·--- - - - - - - ~ . . . . . . 1
financial leverage. Financial leverage refers to financing a portion equity shareholders duetoh • Mrlirt,bP - e ange m the level of activity F' ed
of firm's assets through issue of securities bearing fixed rate of of financial leverage. ::-~...... pe~00 regardless of the level of activity. It is onl th • costs re~_constant
interest i.e. debentures, preference share capital in the hope of -
lhe increase m the business activiti F' Y e vanable cost which increases
a revenue or not. When fixed costs a es. ;,.ed cost have to be incurred whether the company
enhancing the returns to the equity shareholders.
Financial risk refers to the risk of possible insolvency arising out of inadequacy of av isfusedchan. Op_erating leverage is r~':5~?se::tycet~e pro::ility, it~ said that opera~g
cash as we~ as the variability in the earning per share (EPS). The financial risk depends ges m sales on it EBIT Wh . use operating costs to magnify
:e prOJ?Orti?n ofborr~wed funds~ the c?mpany's capital structure and the variability of m
0
in profits is more than s
th
•
th~ si~tion detenorates, the firm will not be able to meet interest payment and repaJ lillliooship between th firm' e percentage change m sales volume. Operating leverage is the
en fixed cos~ are there in the cost structure, percentage

of Pi:u'°Pal amount. Therefore, through the use of debt financial risk of the business • e s sales revenue and its earnings before interest and tax (EBm.
. causing more and more interest payments and thereby, reducing the profit. •
 . _-i.i Manageme11t --- / ,.,,,,....,~·
-
....
Operating, F ~ - c
.,.,,....o1F1,_.... , Ind~
Fundl . ,dst when fixed cosffi exist lll the <ost • -' eassres the effect of change m sal I ' ...
. i,.,,rag< said '°ro~t relationship. The higher the propo"i str,,¾ . fol"'ul' '::, factors. These are: es eve) on EBrr. Op., • •
}lent<, "l""'"':8 ""' . vol•"'~ • P operating leverage. When a firm has ;.• Of,••• 11 pl,,,... tJ,r • d ts •ling i...,.. •
- t,ased on the the<>!) 01 ...."" higher tS tlte brinSS about more than one per cent llced i\ ,,.,0 ut1t of fixe coS
tal ge 11\ afirm
in the to cost strUL•"'-'
-r cent ct,ange in sa1es exists h h
. 1everage w enc anges"'• revenue producchange-~ill.. in~-", I'(rl ,,1,l
,,,- ,,.. f sales achieved•
_.-fL,;es ttll?J'I one t'-
Accordign' to Jo"11 H-t""
11:-'r"-__ ....,.
,.n..,rahng
vr·· . EBIT
r .-_
When the P&rcenti::-~
•• •·-..
egrt4t
trc1i...·•
.. (~ -f1,l
1
'~
JeVel o
• 1e costs to sales or contnb •
•0 rt of vanab
. ,, %( l l a n ~ 1 EBIT is more tha~-i,9 ~--, _prop0rti • • ution.
m £.BIT · . ,erage ::: ~ g e in sates change In sale the Per:;!!- ,1 . 0 0 peratillg le_verage if there is no fixed
Jl£nO', O!>"",;ng 1"'
l
'. @! JO each. The cost I ......_ Is ...,';.._
I XLtd, Sells s,OOo uni~is variable cost. Profit meas~re la caned, '-'i
S •
,;,',;JI~ eosts, operabng leverage will be favour,:,' in <ost """1un, U
f« -p; ! ,r,d its entir< '°' th< sales level mcreases .ope"!bng 1':".9raoe. ..., 1
, rJ f:J'- contribution, it will be unfavourable and negaar_id positive.
•. ' - ~ of operating leverage can be calcuiatoo us· tive. Again ccnim:,," fuod .,.
~lion is
of produdl°" Nl/'I :::6 t 20,00o· Sup~The profit will be t 4 x 7500 = t 30 ooo --..,. , '~ dtb'- mg the above formu1a g with above
.-ill be t. 4 x 5P"" . 7,500 units. ' • ~.. t"f -- follows:
m·· SO,. ;:,., 2,500 """" to 11(],,nge in EBJ!
ting ieverage ::: o/c(hange in sales • Iii' f/11111 5.00o
Operating leverage --....., - - , _ _ 7.SOO
Opera O the sensitiVity of S f t 50,000
increase in EBIT + EBIT !o the change i~"':!_Eli r/f' ,.,ss variable COS t 30,000 75,()XJ
== j;°crease in sales+ Sales .,,,__ - 45,0X>
"' ~FiXed cost t 20,000
10,000 + 20, 000 = 1 LSSS '
= 25,ooo • 50,000 ¢< 1s.ooo
f I denotes that percentage change m profits is equal to the pe, r,,,i,1,ul/Ofl 2 l5JXlJ
Operating 1everage1S.o no rating leverage. This is because of the abse~ce of fixed~ "111 s ~BIT 0,000 33 30 12
- in saJ,s. 1here ope tinuing the above example, and assummg a fix d "'•
·-• a,st ,trueture- NDW, con
• 15MO = 1. = I
- the ,ituation will be as under-. • ,._ • leverage
rltlL,xceeds I then operabng is said to exist. The direct; 25,000
•
t :,,(KX), then depelld upon the state of sales level of the firm i.e., if it is of operating leverage
5,000 7,s()J ~,even )eve! then with every increase in sales, degree of ~ting at a level above the
fkill Sold 50 000 . -.ii;nu below the break-even level then with every m·creopera. g leverage will decline. If
, 75,(XX) U"!'""-''"o . B th b ase m sales degree 0 f
c::;
""' I •
, 30,000 500Q 11111' will also increase. ut • 1 e reak-even level degr f '. operam,g
u,, V;riable ""' @ per un _ -4 ,lfinld. Assuming contribution of ! 20,000 and a W:ed
16 !~~"'&" will be
Cc,ntribllli0n ' 20 000 000
5,000 ~· OOL = Contribution _ 20,000
, _ rured cost , ,OOO EBIT - - 0 - = Undefined
LEB~IT ~'~------ =-------- --~-_1_5_,o_oo_ __,___ 25_,ooo_ t: At break-even level, Contribution = Fixed cost and EBIT is zero)
1lrp,rfaet of Operating Leverage: The operating leverage .. _ .,
Operating leverage = IO,llOO : 15' 000 = t.33 - 1i1e effect ~f cha~ges m sales on operating mcome la111tho 00.. .,_,.,. bo i
25,000-:-50,000 111).liafirmJShavmg a high degree of leverage,smallchange change 8Tings. • 1'
It"""" EBIT - 1.33 timeS the increase in sales. i.e., mcrease lll EBIT is more INI* , . wil have higher effect on operating income. However, ::'DOI._.,. ...,.
..,.... ill ,ales. In the above example, incn,aSe m sales is 50% where•.• EBIT """ by 6.S.1\• lillm,lj not operate ~d.er high operating leverage because ~ ·- _ _ __J
,bcwe phenomena can be asoociated widt the presence of fixed costs m the cosl • -W. 1•lrio&s high nsk with 1t. It is a risky situation. ff the sales decline, it can badly a/feds the
the l""'ffl'g< change ill EBIT is more than the percentage change m sales, the ~llng i.:, ._
Id, the firm should try to operate at a level sufficiently higher than the break-even level
.is said to exist and its measure is called degree of operating leverage. Higher the fixed cos~~ . due to fluctuations in sales can be reduced. Therefore, higher OOL can
increase the
<XIS! - • gr<alff be the degrte of operating leverage. High operating leverage JI,, r1s but at the same time if there is a decline m sales it may cause operating """5
when revenues are nsmg but m case revenues fall, high operating leverage brmgs losses EBIT.
The alternate way to calculate degru of operating leverage (OOL) is IJ ~CIAL LEVERAGE (FL)
DOL • Contribution =Sales·Variable cost . Ileverage relates to the financing decisions of th< firm. Operating )everag< , -
EBIT EBIT of fixed operating costs, financial leverage arises due to the existence of fixed mteres
 ;. ~- --- 1
- -- - ------ ----~ -· ••• •Operat;;• ~" "' !~ ~I II II IJ
•' . '
• EPS = ~ - 1 9 0- 0 - _ S .
. . . ; . ~ 200
• - •• ; . , : ; sources, debt and equit y. 0.,bt • • (
.;;; ,;;. ... ol
does ~, , from the above examplehthat as we introduce d200_
h ebt - 9
whic h , •• Ill the l
tw~LS a source offifunds h the EP5 as gone up w en EBIT level w kept 'Dnstant 5u~" uctu .e the
IS~ ¢fl capita
an be raJ·sed trorn£ uity
l\ot j,,_ fl""
rm, w er~as equity di~,_v~ i,,re
- for the bus ~ c cial charge• q Obli ation of the flt Ill'· E~ 6 ,500 i.e., by 62.5% , then as
"°"'" ""'l g st be paid before making any
p EBrr level
dwge>· nmd5 • es a fixed -
-- •~ I ;,("_ .. ..,¢to EPS = (6,5 00-~ (1-0 .5) 311:/\
c1,arge that rnu f. d . jt!P
of chargrest
fixed-~re
an"'funds ond
e· obliga eb!S
tion- It is -:;ed
a 200 - = ~ = flS.75
te of 1Xe Rnancial "'"'89e ...
1 ii' to f 6
t when EBIT is increased from 4,()00 f .
• ' t xisten
es do "'• firm to ••• """':-,i, fixed ~-e. 62.5%, EPs has m·er""d
,s M•st,aret,oldet It> frO"' the e n,ese d,arg Henc
5,·.e., 65.78%. EBIT e, the prese nce of '"""" "1 char
>-
es are magn ify the ~ ..,e cat' see7tha
JS th
• I leverage res~ iJtCorne si:rear n- cial charg es to
n,erefore, chang es In EBIT on ...~,
charg • ge "'1ps the !inn to
f,na n~~ - ;,, the firm, \srr. n,ese finan not. effect . on e level of EPs.
equt~
O these financial eemlr ., per """8 . r,,;. 95 " of change in
cial
[;nancial u - ~the -ge ,n ""an y EBfT °'r
g older s. More - -:- - - - ~ .-'...in' t1te f financial leverage IS the measure of finan 1everage and can also be ca1cui,
~ge the ~rnp ~~ft after payin 'hareh old '-.I we ' 0
the equity ,hareh mings available to equity
not fr_'
to be pmd f profi1> w!riCh ,s equity cap·ta l· ted
a cheap er sourc e of finan ce duet °'"1 ; .W}tell. capital structure consists of debt and 1 .
!. c a n ~ = as financ ial~~- ~ ,
any~ ~di, tril> Ut,d ant:
(hargeS~t in finaJ\dal strU use debt is
regar bility of the firm to use fixed . EBIT - - EBIT
per share . -....&ls (ij f financial leverage (DFL) = e - Eiif
earni ng charg
use~ per shaJe (EPS)
~ty. - 6,:° -se
leverage is
s ;,, EBfT
the~
"'.: :,;,,s
,
firm's
when ever a firm has .debts or oth,, IJel"' o EBIT
apital structure consists of debt, prefe
-FUla ncial
rence and .
equity capital:
.
"fuma nciJll g ,, In other word s, use of fixed charge
in th~ ('~ c
~tructure~ongwith owner's equity capital
magnify the effedS [ever; W]ten
EBIT PD
to Acxx,rding to Ha'::[;/o~ in its capital °"~ P DFL =
azrrym gfixd. _ _:ereng ce sh.are capita l etc •. t nee of financial leverage.
of1•1.-Jc tr11es pn:i • the eXLS e (EBIT - I) - _
..-
sudt as d~ company results in assumption that firm will earn more than the%! · (1- t)
of funds (debt and preferen~e share capital ). U It.
capitalisatJO n ~f levera ge is calcu lated DFL = Degree of finan cial lever age
charges then the difference Will go to It.
The fjnanCial assets acquired by th th th fixed est sources of fun~ gives extra r~, ~, PD = Preference dividend
ctiarges paid on the investment) are rnore 0 fix=d 3f -inter t = Tax rate
e.amingS (retumS Therefore, the presen;~1
on equity. But in case the earrungs are not enough,
s will lose the returns and EPS will decw. I = Financial charge i.e. interest
equitY ~ld ers . It is also called ft ~eho lder y shares, an EB!r oft 3,00,IXIJ ....., _ liabili ofe:
r« oomp1e, if the firm has f 10,000 equittax rate is 40%, degree of financial 1ev~ °" willtyb
• ~ti,ed-finanda1 charges then•the s EPS. It meas ures the effect of ciiai, f"'m, """"- nee dividend of t 20,000 and --o~
charg es. en EBIT and y,w- -•
due to use of fixed-fjnanc
a,vt!! • the relationship betwe
ial
= ~~~- -;:-;: 3':::- :()() ~,_0 0():- ----
fjnanCial leverage lS
D\ EBlf on lie level of Ef'S.
financ ial levera ge
_ %Q,ange
- % Chan ge
in
in
EPS
EBIT I
J:=::-;:....,
,-•-- •-•- _. ,.,......__

to the change In the -

(3, 00,000 - 40,000) - 20,000 + (1-0.4)
3,00,000
-
= -=-= ~-= -=-~ =---
"'" •- 2,60,000-(20,000 + 0.6)
or FL = 3,00,000 = 1.
Increase in EPS + EPS 2,26,667 32
= Increase in EBIT + EBIT
ula let take an example. Let a comp any is
ture
havin
with
g an E:
4,
~4! of
as...,.. r-
ll the EBIT increases by 30%, (EBIT --
-- -- -- -- -- --
t 3,90,000), then EPS--
-- -- .-
would be as follows:
-- -, .- -- -,
, any us JS• havin • g a11 eqlll•ty capit al struc
and To taxexplai 50%form
n this
rate is and comp Particulars Ir "r
divided into 400 equity share s of t 10 each.
(EBIT-1)(1- t)- PD EAT -PD 00 3,00,000 3,00,000
. N 40,000
EPS= N or Less Interes t 40,000
2,60,000 3,50,000
Where, I = Interest on debts 1,40,000
PD = Preference dividend . Less Tax (40%) 1,04,000
N = No. of equity shares outst andi ng Pirtla1tertax 1,56,000 2,10,000
20,000 20,000
(4,000 - 0) (1- 0.5) = 2000 = 5 less Pref. dividend
400 d the 1,36,000 1,00,000
EPS = 400 ngs available for equity shareholder •
met f 2,000 , 10% debe nture s an 10,000
Now suppose, total capital requirement is by llo~eq
Bis ity
u share 10,000
share s of f 10 each ). 19
' 2,000 is raised by equity share capital. (200 13.6
 ----~-
-----~.... _... -- Operating, Financial
8nd Cambi
-
' .•.
---d~;,;;;;;;;.. . - ... •' --------
,.,... - ven level and both EBIT and
'ledl.et,e,--
! (k - - - _
,,,J.""
•
---- - -wai

f~ . 7% .The financial leverage (FL) is 13 ,,. ,, ,,, ; i,reak in the same direction. r~' financial i;_-;- - - _
. 4 + 13.6 "' 3~· EJ'S is 1.32 x 30 = 39.67. If return • an<1 J:lb.. , fJ va.•, . e firm wil) b age Will be~- - -
-
haS
, ,_
by t 5.4 ,.e. 5~age increase in on lt\\>es ~utr ,)e5 financial break e operating ab oUrabie.
EBIT and EP ev~levelofEBIT ove the
I
bv 30%,
haS ~ - · nnanoal )e\,erage favourable. • ' 5 Will vary • and both 1
percet'iS direction
helps the finanoal manager to ta • in the sarne
> cost of debt. . lftt""ge.: finllndal lever~rinvestment (ROI) > cost of debts (;e <1~ . tiOJl <: Fixed cost, operating 9. If rate ofretum o .

1
~ o f ~ l the inarkel If the re~ use the fixed charge securities to •d),
boft'O"'rirl8 frO~ fjnancial manager cad EP5 of the firm. If the financial lt\Cfease
S i c011tr1b~ unfavourable. The firm is of debt (k )
fi
n mvestrnent (R
. d or cost of pref I
01) <cost ,
I

J Je~era_ge :iow break even level and both

]e\!ef3ge is fa~•ourab: equity share holders a;one and financial leverage is of no le\>erage • T~a~~1al leverage will ~ence capital (kp), '
~tillg ot able to recover even its fixed . e irm will be o .unfavourable I
_;n..-; a,•a1lable ...;...o- should not be c.ved financial charges which incr Use. li~
ea,,....e- le fhet\ t,orr0"'"'0 there are'"' ease th ••"" ESff and n financial break even jerating below th;
. unfa"ourab can be applied when hould also be able to interpret the risk e \v~ able to recover even _evel of EBIT and
)e\ieraSers. n,e fjnancial rnana~~ debt is a cheaper source of finance d its fin . not
, d the anaa1 charges.
higher fjnandal Jeverage~ However, at the same time high finan: to its~
~ith-~ili~ it brinSS advantage to !11~.ca~ the large content of fixed interest charg lev~
(iedll'-...., , , . __,.;"I risk- Jt also in 1 es. ~LEV£RAG E(CT,) .
=--,1;,.,i1e5 high IJilill,.__. and financial leverage
11: - operating leverage . P . leverage (OL) explains the business risk •
.. Financial Leverage , ~(FLtlfl)gdeals with the financial risk of the firm. Bctomthplexion of the firm and finan
:~ . · h . u e firm 15 • cia1
~~gt . • iw~ erefore, a finanaal manager s ould consider both OL concerned with its total
L-------- . , bility to 1. Finanoal leverage 1S the ability of the 1
1
;;. 'llt of change in sal~s level on EBIT and financial levera~d FL. Operating leverage shows
, 1. e>perating ieverar 15 tlte firxn s the to use fixed financial charges to
use fixed opera~ costs to operating
~effectThUS, a firm having both OL and FL will have to ~uses e~ect of change in EBIT
the effects of changes in EBIT on :agnify • to 1cnow their effect on EPS. Therefore, combined levera e is combmed effect of both the

I effect d chaJl8E!S m saJes :e\ensitivity of

ina111t (EBI1J. It~m>. the sales, le.
the finn's EBIT to the u--o- m
It measures th~ sensitivity ~f the finn~s~ ~ymg both the leverages.
to the change m the EBIT, i.e.
. ·ll % Ain EPS Hence, DCL = DOL x DFL
g cakuiated. This is calcuJated

%Ain EBrr Fmanoa everage = --.._:..:_

Where, OCL is degree of combined leverage
.leverage = %A in Sales % A in EBlT
I 2. It is related to the presence of fixed DCL = % Change in EBIT % Change in EPS
! 2. It is related to the presence of fixed financial charges i.e. presence of fixed chari! % Change in sales x %Change in EBIT
operating a,st in the overall cost structure securities in the overall capatalisation of Ill
firm. DCL = % Change in EPS
of thefinn
3. Degree of financial leverage (DFL) can be! % Change in Sales
, 3. Degree of operating .leverage (DOL) can be EBIT I ,,
caJculated by: OOL = EBIT
Contribution calculated by: DFL = EBT I DCL = Contribution x EBIT _ Contribution
EBIT EBT - EBT
4. DFL depends on the rate of return on
4. OOL depends upon the amount of fixed investment and the cost of capital on fixed The combine~ leverage or total leverage arises from fixed operating costs and fixed interest
a,st, level of sales and profit-volume ratio apmes.The The _CL 15 the percentage change in EPS resulting form percentage change in sales level
charge securities.
(oontribution to sales ratio). llfrlgetotal nsk to whi
in diffe d ch a firm 15
• .exposed can be managed by combining operating and financial
5. Highoperatingleverageindicatespresence 5. Hisdl financial leverage indicates presence tima low de rent e_grees: If a_ high degree of operating risk is attached with a business activity
of high fixed operating costs. of nigher finance charges or e~p~o~ in salgreelfof
of more debt funds in the cap1talistton Ii nsk would reduce the fluctuations in additional earnings due to
ltigperm:;· th th~ firm wants to choose higher degree of financial leverage to increase its
the firm.
costs e~ it should go for lower operating leverage or should incur low level of fix~
6• OOL_measures the business risk in which a 6. DFL is the index of financial risk a fun\~ '5 ll\ EPs. DC e unportance of DCL lies in the fact that it indicates the effect of m
firm 15 operating. facing.
Proj .L plays a very important role while choosing financing mix for new project- If
•-, \'ery 18 very ri~ky then the operating leverage will increase. If its financi~ leverage
7. It helps in investment decisions 7. It helps in financial decisions. its ~ t _the time of the investment in the new project, then the will have. to
8. levlfcontri~ution > Fixed cost, operating 8. If rate of return on investment (ROO >~ to keep ~al plan and the new project can be financed through the ~ue of eqwty
erage 15 favourable• The firm•IS operating • of debt (k") or cost of preference~a!...
------- --- ------ ----- -- ilie financial leverage low so as to keep the total risk constant.
_ _ _ _ _
r- . Management ••,
'-....,_
- - - - : : ; : ; - - - - - _-_-_-~-_---~~_-_-_-~-_-_, - . _,,, ''d, r-1n .
anttal al'ld
"Vfl'lbii-,
"A~
7
- nctsrn~ntsls of Financi•I e(ll~~
Fu {inn can be classified into thr POINTS TO REMEMBER
I "erages, a . . ee sj1... •
. of e,-i.stel'lce of e . tion is one where a firm 1s having both '\latj°"s
the basis A riSkY s1tua or...... : ..,.ip~• t,dmlqueof anaiyzmgri sk-.....,""'
. k sit111Zfiorr: •ghet Jevel. rcrati,,._
,,,.-.JJtlll _..,re consists of two type of sources of fina
ile1eristicotd;u_ -
(11 Ris ·a1 leverage at a hi ·tuation is one where one of these two l ~ig' 11':,_j stfllc;•-- fi -·~alh....~ -
finano . . . A norlllal s1 evera8 c,r-_, . the employmen t of xed assets or fund nee, i.~. debt . - .. •
~ is 1-.... ted with two types of risks, bus· for Which ctn.d equity. ~~ ,
· Norm"l
(111 srt1111tto,r; . b·on is one where both these leverages are lo ."t
iS
--A ther is Jow. fl"' i5 referS to the~ari_a~ili~ of EBIT as a ;::t:k and has to pay fix
a.JIU o . ,r. An ideal s1tua
"'· riSk is the vanabil~ty m the earnings of th~~ II\ envnonnien . @d CX!sts.
c;m 1deJJ sit1111tt0 • noNSOFJ..EVERAGEANALYSis t,orne by the ~wty_ ~hareholders due to th:::ty sharehotd~ll'IWhichafinn '
,.,. 6B"l(lr ~AND~ an
analysis is . important tool in the h • ~·.:.,. leVerage i.$ the firms abilitytousefixed oPerating of financial le,, clJld additiona}~l!s.
d. ands f
8.7 I.Ml"-"~,flerJeTllgt !Jul1JlsiS: 1.,everage . taking financ1a1an mvestment decisions o a aru_ _ l leVerage is the ab~ty of the firm to use fix ~'°lllagnifylt-eeffett erage. risk of
I ~~lftc the finandal ~ger 1Iland financial risk and their effects on the tn~re ps·
1t,ll<"f"~ easuTC thebusmess ful. ch • • th eat'nin i ~-= itl EBIT on the ea~g per share.
itted leverage anses from fixed operatin
ed charges ofdtane,isin~
to tr1agnuy the eff Flit.
manager- . anal . isquiteuse ma e1vmg ewealthlllaximisa _&sa.,,~
helpshin'ltom
Jtalso •tvshaJ'eholdetS· nus Y515 sis can be discussed as under: tionObi....~ , ~shows the effect of both operating and c~ts t!i
and fixed interest ects ot
. . f]everageana1Y • ncial leverage on the a , , . ~ c-
'-"~- - ..
•
r ~as_:._
,-L..,_
totheequi., V
of the firm. The u~ty- o t decisions: This t~qu; is ~~te useful ~hile takin .
It helps ill tfl}dng e measures the firm s ability to use foced op &_II\\restr.~
1• decisions. The operaang Ievera! sales on its operating income (EBIT). The ;rating c%ottJ. LIST OF FORMULAE
_a,.,.+c of changes f. tm t d • • crease • '
~gnify the eu"'."'- the direct result o mves en ec1s1ons. If increase • II\~ ra ng everage :
nnP!'3ting rosts 1.5 due to th . crease in fixed cost due to certain investment decis1.~Xn-.:
ill ' C'"II 0
vr-- . . more than able e Ul investment
d ••
ec1s1on w increase the ea • on, \i
a,ntribution IS . and the % Change in EBIT
operating leverage 1.5 favHom wise use of funds is possible. lllings a.,,~ I)OL = % Change ir, sales
(ll)
'tJ sfiareholders. ence,
to equr : . nancial decisions: This technique is also quite useful in evaluatin .
2 1thelpst1ttflk inK{! ailable to a firm and also to the determinat ion of op1,;- gdiff~ Sales - Variable cost Contrib •
bill' f th firm t • ..,.u1urn ca. -----~ =
OOL ::
utlon
&:.,.,...,,-inc;,- altematiVe5 av (b)
financial leverage measures the a ty o e o use fixed financial Pili! EBIT EBIT
w--"0

structure-
on aero~
r:;::i 0
f d bt capital to magnify the effects of changes in EBIT on the EPS If~
en/(Ron is higher than the cost of debt then the financial leverage • raie~
1,Defdoffinancial leverage (DFL):
retwn on nw ,., b . 'ti' t nh Will~ % Change in EPS
.favourable and firm can issue fixed interest eanng secun es o e ance returns to the eqlliti (o) DFL =
% Change in EBIT
shareholders. •
_ 1J helps ill measuring business and financial r_isEks :ITOpderatinthglevera1ge is used as an indexd Where, EPS
= :-:---:(:--=EB_IT_-_..!,1)~(1_-_..:..:t)~-...:..,:PD:__
3 business risk. Business risk measures changes in 8 ue to e emp oyment of more fwids· No. of Equity Shares Outstanding
the assets having more fixed operating costs. It helps the firm to measure its ability to use~
JWhen capital structure consists of debt and equity capital:
costs to the advantage of fum Similarly financial leverage measures financial risks and theabii
of the firm in maximising the earnings to the shareholders due to the employment of debts. • EBIT EBIT
= EBIT - I or EBT
4. It helps in maimisingthe wealth ofshareholders: The finance manager with the help oflevm,
DFL
analysis will come out with a financing mix and the capital structure by which earnings avaiWI (i)When capital structure consists of debt, preference and equity capital:
to equity shareholders can be maximised. Similarly by using it, the quality of invesbnent decisin
can be improved. Thus this analysis help in realising the overall objective of wealth maximisalD DFL = EBIT

Limita~ons ofleverage analysis: As we have learnt that leverage analysis is a very useful tedrip
~or ;111~easmg the shareholders earnings. But it do have some limitations. One of the imporlll
limitation
calcula
d bt
. of.this analysis JS
~!/iffi
• that ·t consi'der only explicit
erent leverages. This analysis also advocates
•
• • (given)
the use
cost of debt cap1·tat . Degree
of financial leveragttt
.i of combined l
(a) DCL = DOL X DFL
(EBIT-1)- PD

leverage
1-t
(DCL):

1
. e capthi a~ ong as rate of return on investmen t is higher than the cost of debt capital~ %L\ in EPS %6 in EPS
fin ·atriskd % L\ in EBIT
ignores epomtthatmoreand ~ore use of. financial • . an~ • = X =---
equity shareholders. Thee leverage will increase the % L\ in Sales % L\ in EBIT %6 in Sales·
cost of equity. This will t~ectations of equity shareholders will increase and th~reby U\~ EBIT Contribution
th
Hence implicit cost of d bt uc~ ~ m_arket price of share and value of the firm m~Y ·1a1t,1
(b) DCL = Contribution
x-- =
is on account of its ass::n ~apital z.e. mcrease in cost of equity is ignored. Another~ EBIT EBT EBT
ption of constant cost of capital which is not true in practice.
 - - " ' - - - - - - - - --•11u np1na
F
l"IClal lfld "•~·-- - .•-
""""binecs
9
Break-e ven sales , = ~age
~.\4 80 8.15
P/ V ratio ,.
. l/3 ,. ? 2
C 0 ntnbut ' AO~
( ·: P/V ratio= 200
Sales "' 6 1)
. bl cost of' 25 lakhs, fixed costs of, 6 lakhs·, }"" ,00,000 ,. -

:c,
u3/o d~ 3
f '40 lakh. vana e
I Break-even sales (units)= ~ o s t s
,
mumatiow 1. A fi~ has sa.: 45 Jakhs- "-Ont ributi o;---- - 80,00Q
of, 30 W:hs, and ~wty ca~ and financial )everage. . Per unit • "' --...::.::. :: 10,00o
Calculatt ~ting
[CApq
Noi,_~
( ·: Contr'i'buti'on per unit= Selling pnce - Variab
8 un11a
-,. .ning before interest and tax = , 1 20 000 le COst :::> .,.
<Jt -16:: '8)
I I
i;o,•-
Sutrment of Computation of EBT
SollftiOIC
£arning per shares (EPS) = Earning avaiJabJe to equity h
'
40,00,00o
25,00,00o = 45,000
No. of equity s areholder,
shares
Salts
u,s \lariab~ co,t =?4.50
6,00,00o

---
~c)
--:-:-:---:....

--
u,sn,ci,dcad 9,00,00o Operating leverage = Contribution 2 00 ,ooo I

::: 1,67
-
3,00,00o
-

~Jncx ,a,t(E Bm EBIT -

las 1nlffl5t (10% on , 30 Jald,s)
6,00,00o _ 1,20,000
Financial leverage =
EST - ::: 1.33
EBT Contribution = 15,00,000 = 1.67 times
(i) {¥rating Jrverage (OL) = EBIT 9,00,000 ,-,,no• 3, The following data relate to RS Ltd:
. _ =
9,00,00 0 =
l.5 times
(ii) fiNnci.al Jrverage (FL) - EBT 6,00,00 0 before interest and tax {EBIT) r
10,00,000
!ittd~

-
2. The following are the operating results of a firm: £.,:nillg before tax (EBT) 20,00,000
ltqUired : Calculate combined leverage. 8,00,000
25,00()
30,00() [CA. PCE, May 2008)
Sm(uni ls)
lnllerst per annum 24
Selq pra per unit 50% Combined leverage= Contribution
Taxme 16 EBT
Variab.lt Ql5t per unit 10,000 Contribution = EBIT + Fixed cost
No. al equity lham
~~per~ E : 10,00,000 + ~0,00,000 = t 30,00,000
Earning per share (iv) open~ BT - t 8,00,000 (given)
Compute (1) Break~en sales (i1) Earnings before interest and tax (iiz)
[ICWA. In/tr lxr. llm,
leverage (I,) financial leverage
Combined leverage= 30, 00, 000 _ 3
Statement of Computation of EAT 8,00,000 - ,7§
Solidiort:

Sal5 (25,lkXI unit@f 24 p.u.)

'
6,00,000 •
.,,_lioii 4. SR Ltd• had the following balance sheet as on March 31, 2010
4,00,000 r in erore
lavariablta.t (25(kX) ww@16p.u.)
2,00,000 --•Eq uity
Ccmlributicn
Lt# fixed a>ll
80,000
_,~=:::--------l~Amcm~~L_!_Assels~-J_ ~Amoin~_j
,..._
1,20,000 assets (net) 25 10 Fixed
Openting profit (EBll) -....,.~ =(one crores hareso ff 10each) 15
30,000 2 current assets
Las intere,t
90,000 20
EBT
45,000
r......._ 8
Lasw:@50% _:.-
40
EAT 40
 8.16
--- -~~
F__,- _, ..
-• - - ~er:
. • -en is as
. ·__, infortnltiOO S1' .1;.,a in~)
Tht,ddibcw- ,an(txciU..,.-o
C()9t (70"/o of sales)
fi,crd(OiStsper~ (X)SttatiO y,t11blt
variable opera~ ratiO I?
a]andng figure)
Total .-CS __ · ) C b' ed 1
...._., fi¢I cost (I,
JnClGlt tzX ra~ ri11S and aw ...-,nt
-:. . cial leverage (1v om m everage I?
(.a)cUlatr the tono- . ieveragt (111) fu,an A f f ~ ~ (l,alancinS figure)
(it)orer'ting (Ct\,!>£.//,.,_ v-·IJI' fJ'1
(i) ,.__.,..,..;pershafe
~•-..,.- -~-~,~ (giVel'I)
..rr-Etl' , 4()o/o
I"'' u:,sfaX

. of .a)d: _ Sales _ = 2.5 (given) ¢ f nPtating leverage (OOL) = Contribution =~-16

(..ak:8l,tiOII turnCJVef' ratio= Total assets o Or- EBIT 1950--
rota1.-is IR'- ~IT I

. Sales = 2.5 )( total assets O

f fjnancial leverage {DFL) = - = = 39
•• = 2.5 x 40 = t 100 crores. (i) pegree EBT 950 19
of combined leverage {DCL) = OOL x DFL = 16 x 39 ,. 48
S~of£arninS afterTax (EATI (ii) oegrte 13 19 19
o/c n.,,,~ .

--
<r in crortJ DCL =
o~15emEPS
100,00 WekJIOW,
% Cl\ange in Sales
65,00 % Change in EPS = OCL x % Change in sales
s,.kS '-->.I. o:,6t (65"1, of sales) J{e!ICt,
111fV- 35,00 48
8.00 = 19 x 5 = 1263%

-
~~fi,ced~ 27.00 ,. Consider the following information about X Ltd.
' paiat (EIIT1) 3.00
Ope1llf" : . - tm. oI t 3J crorrsl r
24.00
12,00,oo)
9.60
m 3,00,oo)
lllflll~) 14.40 24,00,oo)
EAT 60,oo)
EAT
_ 14.40 Crores = t _ ~-
14 40 40'Y.
trPC:\
faming per share,...,.,,= 1 Crores (»;u)ate the degr~ of ope~ating, financial and combined leverage. By what pen:entage the operating
(1) No. of Equity Shares -
,ilswould increase, if sales increase by 10%? (B. em,, /HJ DtlJri lbw. 2007)

Operating leverage (OL) = EBIT

. 35 Crores
Conbribuhon - - - = 1.296
= 27 Crores

EBIT _ 27 Crores = t.12S

-- n...-.
.,c,. -it
.
..... of operatin'g 1everage (00.L) = -
Contribution
- - - = -EBIT
EBIT
+Operating < -ca;t
- - = - - - . : fixed
EBIT
--

Rnandal leverage (FL)= EBT - 24 Crores = 12,00,000 + 24,00,000 = 36,00,(XX) =

3
12,00,000 12,00,(XX)
Conbribution _ 35 Crores = t.458 (i1 Degree of financial leverage (DFL) =
EBlT EBIT
(iD) Combined leverage (0.) = EBT - 24 Crores
=---
Pref. dividend EBT- PD
(EBIT-1 ) - - ··-
(l- I) 1-t
llh,mmn 5. ~ider the given information for XYZ Ltd. (r in Wm) 12,00,000
8~
= _ _..;..__60:;-:-::;,ooo=--
Sm (vwblt cx,lt 7f1'4 oi uleJ) t,950 3,oo,ooo- (1-0.40)
00 950
m 12,00,000 - 12,00,(XX) = 6
Tu ratt . . r share if ~es
CaJculate different types of leverage. Calculate percentage change in earnings pe (HJ, Otlhi Uf!Jf· 1 = 3,00,000-100,000 - 2,00,IXXl

by S per cent. (8. Co111

- ••
Fuocsarne"
·
1915 of fi08""'""
---
- -..i•I tASOagemen
t

_[)OL x DFL = 3 x 6 - 18 _
..... /
,, ,,

_, . • •
.
Operating, Financi·a1 -

. Jl'I has sales of t 10,00,000, variable cos

•• 1, f. ()()O{it t 10% rate of interest. What are th
a . b f e
8nd~

t of f 7,0() nnr.
operatin and
Lt'lerage . . .
-
· . leverage (DCL) -_ [)OL x % Increase in sales = 3 >< l0% _ . Nl ,vw fix
f s,vu, double up it~ earrungs e ore interest and tax E g, financial anded COst off
of cotnb1"ed fit (ESJ1') - • 2

,
- 30o/. JI- ..,a11ts to entage basis? ( BIT), how rnu h con,bined .00,00o
- (m) se in operatillS pro) • r
-~ oil
• perc c ofa~- erage,,
._ Increa inESIT St.ltement of Present Profit in ~les "'OUld
"';nerease___::.:..;.-;-:
...::..::----= ;nJ1l Sa)e> 4 .
(•: I)Olr ,_ u,a-ease
. of Radhi
.ka Ltd- consists of Equity shar~ capital oft 10
f l0% debentures. The urut sales incre ,00,~ r
tiC1fl _ ThecaP1~ 1; tOO) and t 10,0?,()()(l~ce is t 10 per unit, variables costs amoa5ed by 2()Pt.... lfiS vanable cost 10,00,0(X)
7
1ll115~~equity share is0()0 units, the sellin~ P me tax rate is 35 percent. UI\t tot 7,00,00Q
tiofl (c) --:_
value nM units to 1,20,
frotn 1,00,uvv
.. rv1 ()()(). n,e inco
ainoUJ'lt tot 1-t""' ,;u
'- fa%ed cost 3,00,000
lfiS 2.00,000
and fixed~ to ca)culate : --.:....
-4' t t0% on f 5,00,000

--
1. you art u,crease in El'S- OO 000 and 1,20,000 units. tp· 1111erest a 1,00,000
(i) -n.o .-ttntage_ --~•1 1 erage at 1, ,
of nna-i...:- 0 uruts.
• ~re iax (PBTl
l•... r-· ev and 1,20,00
-~ The degrte . leverage at 100000 , , . . r/Jf 0perating leverage = Contribution_ 3,00,000 50,0(X)
( 111 degref of 0 peranng . d financial leverage m relation to increas . EBIT -ioo,"ooo = 3
(iii) The d.a L..l.•\'iOUI' of operating an [B. Com <H) ~?rOdUN;.
-coaunent (Jrt 11~ [JCI... units, tun u~ financial leverage = EBIT = l,00,000 _
M IVVI to 1,20,000
2.
fro1J1
1,,.,.,,,.,..,., Stattmen o
t f u]culation of EPS •IOiij EBT 50,000 - 2
1,00,000 (Units) Combined leverage = Operating leverage x Fin .
1,2?,000 (Units) anaal leverage - 3 x 2
r s,1115 ,i,ilS,
' t . d to Double the EBIT: To double the EBIT we r •
o...Ulrt eqUll'e 100% •
-
• .
:: 6.

-i
'
10,00,000 , ,..,. % fl in EBIT 100 increase m 1t
1_--
3
or 33 ! o/c
6,00,000 7,20,!Xk) ;_,.t, OL = % fl in Sales => = % fl in Sales % change in Sales ::
$81115 -:-:--
LJJS$ variable cost 4,00,000 4,80,!Xk) 3 3 0

2,00,000 2,00,!Xk) EBff will become t 2,00,000 (Double) at the sales level off 13,33 ( 1 .
---:--- ~' .333.33 33 33-% increase)

-
I LJJS$ Follld cost 2,00,000 2,80,!Xk)
3
I pdd (EBIT) 1,00,000
1,00,000
1,00,!Xk)
,_-. . 9 x Corporation
.
• has estimate
il!IJI is sold for f 14 per urut.
•
. Th
d that for new product ·ts b
t reak-even po·
e cost accounting department ha . . . m 15 2,000 units if
t •
I 1,80,!Xk)

--
LJJSS--
EST 35,000 63,!Xk) ~,ii unit. Calculate the degree of opera~g leverage for sales volume ; ~:tifi~ variable cost_ of
0
I LJJSS Tax (35%)
EIJ'
65,000
10,000
1,17,!Xk)
10,00)
*do you infer fr~m the degree of operating leverage at the sales volume of
,idrir difference if any? 2 uru~ and 3~000 uru~.
,500 uruts and .,,ooo uruts
No. cl ,qi8:'/ stiareS (N) !,Will: Operating Leverage
EAT 6.5 11.7
EPS=- Patticulars Break-even Level
N 2,000 Units
Contribution 4,00,000 = 2 4,80,000 =1.714 2,500Units 3,000 Units
Operating leverage= 2,80,000 r r r
EBIT 2,00,000
2,80,000 !Ill~ 14 per unit) 28,000 35,000 42,00)
EBIT 2,00,000 = 2 1 555 uss Variable cost (f 9 per unit) 18,000 22,500 27,00)
Fmncial leverage= - = 1,80,000 = •
EBT 1,00,000 :.tbirl 10,000 12,500 15,00>
ltssF'ixed cost 10,000 10,000 10,00>
Omdlllion: With 20% increaSe in sales:
:profit Nil 2,500 5,00>
(1) The o/o increase in EPS is ( 6; x100) = !:! x 100 = 80% ,.
leverage = Contribution
-.:::::::: EBIT
Not defined
( ·: at BEP, EBIT will be zero)
12.SXl = 5
2,SXl S.00>
=3

(iJ) The degree of operating leverage has decreased from 2 to 1.714.

I~ sale volume of 3,000 units, the operating profit is f 5,000 which is double lhe operating P~
(ii,) The degree of financial leverage has decreased from 2 to 1.555.
.Hence, with 20% increase in sales, firm's EPS has increased 80%. This has also resulted a:::,
business and the financial risk of the firm. Firm is utilizing its fixed assets and debts to lhe a
1
?
lhe_sales volume of 2,500 units. Operating leverage is 5 times at the sal: v~~:e 0 ~fit is
b t~c~ease of 20% in sales volume (i.e., from f 35,000 to f 42,000), the pe g p
y OO Yo i.e., 5 times of 20%.
shareholders.
- S.20
--=.
----
..
mAnUIIS
funuc,...-
-~,
-- . - - ~ t
of . · • ritl8 balan<:e sheet as on March 31, 2018
,,, ,.• ..-~

11te fo11o
Operating, Financia, • ---- _
r

wing figures relate to two compani .

es.
8fld Cornbineci•~-•
age
8.21
the follO\\ ----.----:---:--- ti• ---
.OIi 10, SR Ltd• had Assets
Ill.str' ti

- --
40,00,000 Fixed assets (net)
~-Eq,# Y current assets
8,00,000 1,00o
cepll81oft 10.,cll
e~shlf!~ ~.00.000
R9SI""'-"' 32,00,000 700

-
15%_,,,.,. 1,60,00,000 15() 400
QJ!Tll1IIIIJllllil& 1,-,.S' 50
. . ,en is as under: ----- ----- ----1 ..__ 100 -
100
.. , --1 inforU"ti<Jll SJ'clding intereSt) '32,00~ -......__2X l
The addiD(JI- annuin (ex u
fixed costs pertin8 cost ratio 70% thto: operating, financial and combined leverages for th
~~~ra tio 2.s te e the relative risk position of them. e two companies, and
30% ~on .
Total .-JS
JrlC(llllt ux ratethe followin8 and co,:nment · )E ·
(iii) Combined leverage (1v arrungs per share
~ : uicwate (ii) fjnailCW Jeverage fCA, IPcc~
(ii aperaung p Ltd.
. _ Sales • Q Ltd.
es: Total assets tumover ratio - Total assets = 2.5 (given) Contribution
. . . Ca}cuJation ofsal -~ieverage = EBIT - 300
- - =2 700
EBIT 150 = 300 = 2.33
Worl:ill85· . Sales= 2.5 x total assets . .......i1everaQe _ 150
Ar,.,..... =
- 2.5 X l 60 00 000 =t 4,00,00,000.
EBT(PBT) - 100 :: 1.S
•• I I I Contribution =: = 1.5
-f Earning after Tax (EATI
Statement o - ~ned 1everage = EBT (PST) ==300=3
100
er J = 700 = ls
200
4,00,00,0()() . leverage can also be calculated in the following manner:
2,80,00,000 Combined leverage = Operating leverage x Financial leverage
Sales.cs variable rost (70% of sales)
1,20,00,000 P Ltd. = 2.0 x 1.5 = 3.0
(£lltri,utiOO 32,00,000 Q Ltd. = 2.33 x 1.5 =3.5
Is Operating fixed cost
88,00,000 • •Operating leverage is higher in Q Ltd, therefore business risk of Q Ltd. is higher. Both p Ltd.
. profit (EBIT) 12,00,000 QIJl,have same financial risk. The total risk of P Ltd. is less than Q Ltd.
Jnterest (15% c,f f 80,00,00,000) ;i,,Jion is that where operating and financial leverage are high.
76,00,000
arr 22,80,000_ rilution is that where one of these two leverages is high and the other is low.
Is Tax (30%) ..,. is that where both the leverages are low.
53,20,000
• 12. The capital structure of Greaves Ltd. consists of the following:
EAT
Equity share capital of " 10 each , 40,00,000
Conbribution l,20,00,000 = 1.36
(i) Operatingleverage(OL)= EBIT = 88,00,000 10% Preference share capital of " 100 each , 30,00,000
12%Secured Debenture of" 100 each , 20,00,000
EBIT - 88,00,000 = 1.16 •hiisfor the company were" 1.60 crores. EBIT is estimated to be 10% of sales. Corporate tax rate is
(ii) Fmancialleverage(FL)= EBT - 76,00,000
lirrdcostisestimated to be" 50,00,000.
Conbribution 1,20,00,000 = 1.58 Or : the income statement of Greaves Ltd.
c.ombined leverage (CL) = EBT "' 76,00,000 111L le the operating and financial leverage. ,
"I\IIWill be the% change in EPS if EBIT rises by 10%? What will be the new EPS.
a = OL x FL CL == t.36 x 1.16 == t.58 IB, Corn (HJ Delhi Uniu. 2017)
(iu) . EAT 53,20,000 = t 13.30
Eamingpershare(EPS)= No.ofEquityShares = 4,00,000
p _ . ._. - - Management
.. .
Operating F· _
, inancia1 ancs
---••
.__
~--···' • Cornbinecs -
Fundlmenia'S d Fi incorne and calculation of EPS e '°""pt ol fin,ncia1 leve,age by what l.e,,,,g. . . . . . . . .
Statement of ,,J 11~- ~ase by 6%. perc~tage w·uI th
5ol11ta01C (i)
L:1e working backward)
1,6() 00
I•~
' • (~
.;n" u•e concept of operating leverage by what per~
jtl.s.
(-1 tJ,..-u i1' sa}es-
;,,,"~, concept of levecage by what pe""'" •
tage Will
e laJtabt, •
IJ\coin,.
Ulcrt~
Sa}es . figuteW~ w· EBIT "'a,.,. U d
USS Variable c o s t ~hi)e workinS backWard)
-) tJsiJISast by 8%- . . g ill the laltable inc !her, IS 111,.
66,oo.~
I >JSo vei.,, ..:.'11 the results m view of the above fi om, increase •ii the ~b
eontrlbution (balancln8 figure w so,00 ~ gure.

~m (lO'l'> of sa)es)
USS FiXedcost
~oo·
.. [B. C°'" /HJ
Drl1r1 Un111. 2006)
aperatinS profit \,.,., of financial leverage (DFL) = EBIT =
13,60.~
8
uss1nierest (ij EBT 35!XXJ = -
S,44~ %1ncrease in taxable income = DFL >< '¾
arr l.tSS Tax 8,16,~
8 o crease7in EBIT
(4D'i>) : 8
7 10 : - X Q.Q6 -
-x60I

£AT . 7
- 0.06857 = 6 86o/c0
l.tSS dh,idend ....-ee of operating leverage (OOL) = Contribution 140 (XX) •
!'1 • 4,00,00:) (i) ~·- EBIT =~=~
% Increase in EBIT = DOL x 01,o 40,00J 2
No- of equity stiare5 (N) Increase •
7 in sales
NI ~,.119 = 2><10% = 35%
EPS= -=
N 4, 00, 000
Contribution _ ~, OO, = 4.125 .. n.m"i't of combined leverage (DCL) = Contribution 1,40 000
fn1 aperating }eVerage = - EBIT - - 16, 00, 000 (111) v<b·-- . EBT . ! _ _ :: 4
:: -35
1ncrease m taxable income = DCL >< '¾0 In
crease,000
in sa1 % 4
EBIT __ 16,00,000 = 1.86 · tioll! es= xB%=32%
~---,.;•' je\•erage = - 3,00,000
13,60, 000 - (1- 0.40)
ruwu-- - - StaltJlltllt of revised EBT
EBT-
1-t Psrtlcutars Existing r Altw8" inctNSe
%(hange in EPS _ % Change in EPS
- - lnEStTr
1.86 -
(iii) Degree of Financialleverage - %(hange in EBIT 10 % EBfT 40,000 42,400
Less Interest 5,000
. %change in EPS = 1.86 x 10 % = 18.6 % 5,000
EST (Taxable Income) 35,000 37,400
'186 Or
New EPS= 1.29 + I o·o x 1.29 = f 1.53 • %increase in taxable income = 2, 400
_ (EBIT-1)(1-t)-PD = (17,60,000-2,40,000)(1-0.40)-3,00,000 =~.53 35,000 x lOO = 6-86% (Hence verified)
New EP5 - No. of Equity Shares Outstanding (i) Statement of revised EBIT
4, 00, 000
Where, New EBIT =f 17,60,000 Particulars Existingr Alltr10%k!cr91St
ins-& r
lllutr11tio~ tl. The following data is available for XYZ Ltd.
f Sales 2,00,000 2,20,000

-
2/'fJJ'lti Less Variable cost (30%) 60,000 66,000
Salet 60,0CO Contribution 1,40,000 1,54,000

---
Less Variable cost O 30% Less Fixed cost 1,00,000 1.00,000
1,40,0CO

-----
Cootri,utioa 1,00,001 EBT 40,000
Less Fixed cost
40,0CO
o/c Increase
EBIT s,!kXl 0 in EBIT = -14,000 x 100 = 35% (Hence, verified)
Lesslntemt 40,000
35,001
Profit before tax
 0 - ·- ....
perating, Finan-··c1··~ ·-. ·-..,._ C
• alandCombi~~-

·~ c,tcidation of EBIT
""" ,11t of--:-.-::--------,---
tt·. S,,1,111
·std £BT psrtfcufsfl
(iii) Statement of ReVl

PalfiC«Jl'S 2,00,000 2,16,000 5,00,000

sales ,50,000
$8185 60,000 64,800 Less Variable cost 2.00.000

--
2,20,000
uss ...,j.t,1e cost (30~)
yc,1"' 1,40,000 1,51,200 contribution 3,00,000 -:---
3,30,000
1,00.0~ 1,00,000 Less Fixed cost 1,50,000
1,50,000
L.SS Fixed cost 40,000 51,200 1,50,000
EBli 1,80,000
EBIT 5,000 s.ooo
30
L.SS1n1erest 35,000 46,200 % increase in EBIT = ' OOO
1, 50 000 )( lOO : 20% (Hence, verified)
I
E5T(TSX8t,1elnc;on,ee~)----.J.----~----
of Revised EBT
1
. BT_ x 100 = 32% (Hence, verified)
--;;;;,;;ii;;-------T-~~::---r---
i,1 S.....ttoi'"
%mcrease in E - 35,000 psrt1cu1srs Existing r After 6" lf1Creese
In EB/Tr

----
. data are available for ABC Ltd.
r EBIT
1,50,000 1,59,000
14, The followinS 5,00,00o Less Interest 25,000 25,000
2,00,00o EBT(Taxable Income) 1,25,000 1,34,000
s,lesl6'S Variable cost@ 40% 3,00,000
1,50,0()() 9

-
o/o increase in taxable income = 1, 25,000
, 000
x lOO = 71.% (Hence, verified)
1,50,00Q
~cost
25,000
{ii) siateinent of Revised EBT
£BIT 1,25,0()()
usswerest Psrt/culsrs ExistJngr After 8" ,,,;._
EBI' .i.a,.,....,...,,t of operating leverage by what percentage will EBIT increase if the • in Sales r
(ij Using 11"" ...,......r re IS It Sales 5,00,000 5,40,000
jncreaSe in sales. • 2,00,000
(il) Using the concept of financial leverage by what percentage will the taxable income increaie, Less Variable cost 2,16,000
Contribution 3,00,000 3,24,000
(iii) E8JTjnaea!it!by6%.
Using the concept of leverage by what percentage will the taxable income increase if the SU! Less Fixed cost 1,50,000 1,50,000
EBIT 1,50,000 1,74,000
AlsojncreaSe
verify the 8%. in view of the above figure.
byresults [B. Com. (H), Delhi Univ. liY}J Less Interest 25,000 25,000
EBT 1,25,000 1,49,000
Sobdioll:
(Q ,.._,_ of tin (DOL) Contribution 3,00,000 2
1 -b'- opera g 1everage = EBIT = ·1,so,000 =
%increase in taxable income = 24,000
1, 25,000 x too
% Change in EBIT = DOL x % Change in sales = 2 x 10% = 20%
= 19.2% (Hence, verified)
(il) Degree of financial leverage (DFL) :: EBIT = 1,50,000 = 1.2 a.t,.Non l5. The follow·mg details
. EST 1,25,000 • of SR Ltd. for the year ended 31.3.2018 are furnished:
-
Operating leverage 3: 1
• taxable income
% Increase in • = DFL x % Increase in EBIT
2:1
Financial leverage
(iil) :: 1.2 >< 6% :: 7.2% , 20 lakhs
Interest charges per annum
Degree of combined leverage (DCL) = DOL x DFL Corporate tax rate 50o/o
= 2 >< 1.2 = 2.4 60%
lncom Variable cost as percentage of sales
o/o Increase in taxable income
• = DCL x % Increase in sales e statement of the company
: 2.4 X 8% = 19.2% [JCWA Jnttr o«. 1995, B.Com (HJ, Stm • V, Delhi Unifi. 2013, 2016]
SofwhOII: . n of EBIT:
1 0 .
wo~ gs: . of EBrr. (FL) : 2 (gh-en) "(~ c,JcU 'ti financial leverage (FL) ::: 1•421 (given)
(i) C1Jcalab0ft fjI\IJiOll )e\-erage
EBIT 1,
·
2 : - - :::) 2EBIT -
21 =EBrr 2 EBrr EBIT
EBIT-1 ~~l't - - - :::) (1.421) EBIT- (1.421)1:: EBn (1.421) Earr _
I ::: t 20,00 ::: 1.421 - EBIT - I £Brr:: ,1.421)1
o.421 Earr =1.421 x s,ooo
EBIT = 2 X 20,00,000 ' 40,00,000 [ ·: _
Hef\('e ,
=
iP" 8 (·: t 8.000 .
I::
EBIT:: 11,368/0.421 \1136 27,002 or say t 2'7 ~gn,t n)]
(i:) Calcalatioll of (Olltni,vtion: EBIT = t 40,00,000 fon of contribution: MN
c,JcUI' I
Contribution (•J EBIT =f 27,ooo
(OL) = 3 (given):::) Hence, 3 = ~ ErrB
tin8]t\,eragt _ Contnbu •
Contn"bution= 3 EBIT :::) 3 x 40,00,000 ='
1,20,00,00Q Operating leverage (OL) = 1.5 (given) 1.., ::
Operl
Contribution= 1.5 £Brr _ Ean
sales (given) l.., X 27,000 :: t 40,j()()
(iii) (.alca1atioD of sales: Variable cost = 60% of Jation of sales:
.. ())CU
40
t 1,20,oo,00o (' Profit Volume (P/V) Ratio =40% of sales (giVen)
Contribution = 40o/o of sales :::) 100 x Sales =
100 Contnbution =40% of ~es 40
Sa)es : t 1,20,00,000 X =' 3,00,0Q,OOQ lQO X Sa.Jes:: f 40,500
40
Sales - f 40,500 X -100 ::: f 1,01,250
-
- Operating profit (EBfT) 40
(i:7) uJmlation of 6ud cost Fixed cost = Contribution (iP) (i)culation of fixed cost
=1,20,00,000 - 40,00,000 = t 80,00,000 Fixed cost =Contribution_ n....... ting
.
d 31.3.2018 profit (EBTI)
Income statement of SR Ltd. for the year ende
~}""ld
= 40,500 - 27,000 :: t 13,500
ltd.
inLiihs1 Income state ment of Som Dutt Beuings

-
300
Su5 180 t
Las Variable aJlt (<,0%) Sales

-
120 Ltss Variable cost (60%)
1.()1.B)
OElhi um, 80 60.750
Qrdri,ution
Las Fimi aJlt 40 40,300

-
l.tss Fixed cost
~pm lit(E lll') 20 13,300
ls lnlm!tdmges ~tin g profit (EBil)
20 27,000
SI' Ltss Interest charges
10 8.000
LasTax 150% EBT
10 LtssTax@SO%
19,000
mql flert n (EAT orPAT) 5,700
in respect of Som Dutt Bearing Ltd.: WIiing after tax (EAT or PAT) 13,300
W., ,,.,. J6. f-o1lowing information is available
40% EAT
Pm6t Volume (PV) Ratio EPSa No.of Eqw. tyShares 13,300 = n.33
1.5 10,(XX)
Operating l.ftmge
Financial l.ftmge 1.421 .
"'1a!ioit 17 C Companies based on the following financial data:
IDi!rest Uability t 8,000 • Prepare mcome statement for A, B, and
A B C
Tax rate 30%
No. ofE)llity 9wes 10,000 _ Variable cost as a percentage of sales 60 75 60
Interest 200 300 1200
2
P!q,are the Income statement and find out EPS. Degree of financial leverage 3 4
6 2
[BBS (H) Delhi Unhl. Stlll. ,v.( Degree of operating leverage 5
Tax rate 25% 25% 25%
(BBS (H) DtDri Urriu. Stm - N, 2013)
 ,..-
... ·-
___
.,.,,..,, ,..,.,_..,

,.. lty
_...u,J c•P'\ •nd ,alet
rrr Iproduct 711unit f
CompinyB prtc' per unit f
S,,l11tloii;
~II cDfl '""t/on A f
p,rtkllf,n cotl l 5/IUll//011 8 f
EBIT ..
51,1u11;;tlio11iC sif~"u;.---,--- -..,.,__
Catnalatklft of £1IT1 4 • EBIT - I 2•
structure
-,.,p1t_,1
_!BIT_
I flllT 3 • EBIT -1 Esrr 'I
Equity
/f
0 • -
'Fl -
urr-1 3 EBIT • 4 >< 300 2 EB 5.000
2EBIT • 3 ,c 200 IT " 2- I~ l)ebt 5.000
31T~~-+-t--E_ BIT_•_400_ _f-....:EB:.:.:IT•2At1A
EBE• nvu n.t,tl.t 12%.
ca,' of.,.
Calculation of Operating , __
ol contribution: Contribution ,,.: ""'vttage

·~
Caltlllatiofl Contribution 6• 400 2 • Contribution
1 Contn'buri~ 5. 300
• DOC• - EBIT
, p,,tlCUllfl
A -
2,400 B
1#1111 0 ,. 15)

-
t,500

-
12,000 C
I c-ern,.tlon

--
5111' (,xl ,ilble coet (000 units@ f 10) 8,000 12,000
IJII V, 8,000 12,CJOO
~ofS.ltll 75 4,000

--
~(eoox5) 8,CJOO

--
60 60 4,000
' varilblt CIIIII <"' of pin) 25 !JU Fixed cost 1,000 4,CJOO
40 40 2,000
c-t,O,lltioll (% of pin)

-
~rig p,o1it (EBIT) 3,000 3,CJOO
40 2,000
I
.._., Contribution 100
x Sales • 1500 100
x Sales • 2400 too XSales • ~feYerage:i
Contribution 4000
1,CJOO
-= 9,600 EBIT 3,000 = 1.33 ~::2.00 4.CJOO
' • 3,750 •I 2,000 -~4
151111 1,CJOO
Statement of Calculation of Financial Leverage
~offtxeclcoe t:
1,500 _ 300 1,200 2,400 - 400 • 2,000 4,800 - 2,400 2,400
' IC • (.anri,uldl- EBfl' FlnancJai Plan
I
II
r
: . . ....t,mmt '
3,750 9,600 12,000
WonA
r Ill
r
s.. 2,250 7,200 72,00 p,oflt (OP) 3,000 3,000
I UIJ Variable a,et 2,400 4,800 i., lrurest on debt at 12% 600 3,000
, Cantribution 1,500 lX) !QI
bllore tax (PBT)
I z- fiud COit 1,200
2,000
400 2,400
2,400
11111
2,400 2,700 2,100

'Opmtingproftt(EBn) 300 300 ,_ IY9rlge (:) 3,000 ==1.25 3 000 3,(XX) ,.1.43
1,200 2,400 • :01 •11
-.s 2.700
l'.-,.,.-- dwgel 200
100
1oo 1,200
300
~PIOlll(OP) 2,000 2,000
2.100
2,000
&Ml Illa 1nter111 on Debt at 12% 600 lX) !QI
I la,T1112S% 2s 25
:WIUII * tax (EAT or PAT) _n... 75 -
C
,_blbtlax(PBT)
1,400 1,700 1,100
•
d •tuations A, Band
lllutrltlot, JI, Calculate operating leverage and financial leverage ~n er 51 to the operadi, ~C PBT
'-~(~) 2,000 •1.43
1,400
2,000 :s1.18
1,700
2,000 ~1.82
1,100
and financial plw I, II and mrespectively from the following informatio? relat:ftnancial levera, PIO!lt (OP) 1,000
1,000
and apital 9tructure of XYZ Co. Al&o, find out the combinations of operatmg an ful fjnlnct
10 "II -..1 on Debt at 12%
1,000
lX) !QI
600
which give the hlghett value and the least value. How are these calculations use .._lax(PBT) 700
manager In a company? 400
1 000
~~.(~) 1,000.25
400 •
1 000
•
700
• 1.43 • " 10.0
100
F . -~t Operating, Ftnane1a1 and -.
• -_ __ _ , . ( J ~ •at leverage: /
fa,no s"_..- and fiJlafl O
•• . k\'t' ~ . . I p/an Ill (10)
.,sreak-even Point (Units)
. riOl' of or«'rati"' C <'l )( fin/111('111 .I
'°;,umc#ll Plan II (1.11)
titiDlf DJ
, : ('l~
t,ana :::) Sjtll6"1"' 10 •
. r...-t ,-alut •f Selling price
~•"·
,c
l,eSS Variable cost
t
A (1.33) ,c f 2~00
,..,
:;:, Si~ ,c 1,11 • 1.48 . Contribution p.u. -Ll_oo
• .•at • 1.33 .
-r to take investment and financ _
'-"'""'" ial d .. 1,000
. ..s.,1 fc,r fjna11Cl•al mana at manageable leve1•
o- ecis1n,,. fiXed Co 5t
• af\' ~ - ·u: ol d.e firm • ...111' 50,~

tf\• and to ~ r
tht ~ t l
-ate S at a P
• Th 'b
roduction lt!\•el of 1()00 _uruts%. ehcontri ution is,
r... BEP (U
nits) == F~ed
Contribution p.u.
?>5t
= 50.00,m> .
~ \ ' v t - ·· ,_-A te,-erase IS 24. If taX rate is 30 , w at would be its
. 60 1,000 = :>,000 units
• :'~
~JS 6- dlt cdl'b1J1CU
-.--ti oll A. ~-..1 earning
,,_,- - . ICA PCE, N Computatio
optia ~ . n of Degree of Operating uverage
. of £MIUI IS after tax
ta-.:., ,.._1calab0ll •
o'alleverage i-l
. .
·erage x finan -,ds-JBS(Units} 4,000
"' 0perabll8 1t!\ 5.000
B.000
Jit\'trlge fjnancial leverage (UnitS "Cp.u .) 40,00,000 8.000
24 = 6 )( 50,00,000
50,00,000 60,00,000
~sts 50,00,000 ao.00,000
!115 10,00,000 50,00,000
fjnlflCial )r\-erase "'~
6
::4 Nil 10,00,000 ~00.000
ll,00.(XX)
Contribution 40,00 ,000
contribution 50,00,000 60,00,000
c,peratin8 ~-erage = - EBIT ~)"= =ter r (-)10, 00,00 0
0
ao.00.000
10,00,000
eontribution = (-) 4 (Unfavourable) ll,00,000
= co (Undefined)
=6
EBIT = Operating leverage =2.67
. of operating ~eve~age _decr:ease as the _production
iil ~ lIt shows that firm lS using fixed operating and sales levels rise above the break~en
J ()()0 X 60 :: f 10,000 pain • tin'
costs more optimally (when sales.
== break-even level) to increa • • (E
se its opera g income BIT). Business risk of the mcreases beyond
6 firm also demases,
EBIT %6. inEBIT
FinallCW kverage =EST Iii Operating leverage =
%6. in Sales
EBIT % fl. in EBIT
EBT == Financial leverage to = 2.7

- ~ =f25 00 % a in EBIT = 2.67 x 10 = 26.7%

- 4
f.amings after tax =t 2500 (1 _ 0.30) == t 1750 c: Tax rate@30%) r.(alioll:
Sales (Units) with 10% increase 8,800
llllllhtiofl 11. Tht Kamal Recreation Ltd. manufacturers l line of lawn furniture. The average sell!
a ful . F' d cost for the compallY • Contribution f @ f 1000 p.u. 88,00,000
pria ol a finished unit is f 2,500 and variable cost is
t 1,500 per unit. ixe Less Fixed Cost f 50,00,000
f 50.00.000 per ym.
EBITf 38,00,000
(1) What is the break~en point in units for the
company? . OOo units;S~•
(a) Find the degree of operating leverage at the • d sales leve15• 4' Increase in EBIT (38,00,000 - 30,00,000) 8,00,000
following productto n an
unils; 6,000 unils; 8,000 units.
. d sales ttvds 8,00,000 7%
(iii) Does the degree of operating leverage increa % Change in EBIT = 30,00,000 x 100 = 26
se or decrease as the produc~on anse or decrtast1 •
above the break-even point? What conclusion would you such increa ....,
draw f rom the prodiJ.... Hence, vefified
(ir,) 8YWnat ...
pertentage the EBIT will increase if the company's I •
and sales level of 8,000 units?
sa es merease by 10% frorll wJf.
(H) [)(/hi Un •
[B. com.