Q1. A FIRM HAS SALES OF RS. 10,00,000 , VARIABLE COST IS 70% , TOTAL COST IS RS. 9,00,000 AND 10% DEBT OF RS. 5,00,000. IF TAX = 40%

CALCULATE :

(A) OPERATING LEVERAGE.(B) FINANCIAL LEVERAGE.(C) COMBINED LEVERAGE.(D) IF THE FIRM WANTS TO DOUBLE ITS EBIT, HOW MUCH OF A RAISE

IN SALES WOULD BE NEEDED ON A % BASIS ?

Sol :- INCOME STATEMENT

PARTICULARS AMOUNT RS.

SALES 10,00,000

LESS : VARIABLE COST ( 70% OF 10,00,000 )

7,00,000

CONTRIBUTION 3,00,000LESS : FIXED COST

( TOTAL COST – VARIABLE COST i.e 9,00,000 - 7,00,000 )

2,00,000

EBIT 1,00,000LESS : INTEREST ( 10% OF 5,00,000 )

50,000

NPBT 50,000LESS : TAX @ 40% 20,000

NPAT 30,000

(A) OPERATING LEVERAGE : CONTRIBUTION

EBIT

= 3,00,000

1,00,000

= 3 Times

(B) FINANCIAL LEVERAGE : EBIT

NPBT

= 1,00,000

50,000

= 2 Times

(C) COMBINED LEVERAGE : CONTRIBUTION

NPBT

= 3,00,000

50,000

= 6 Times

(D) CALCULATION OF % CHANGE IN SALES

CONTRIBUTION = % CHANGE IN EBIT

EBIT % CHANGE IN SALES

3 = 100

% CHANGE IN SALES

% CHANGE IN SALES = 100 = 33.33%

3

NEW SALES = ( 100 + 33.33% ) x RS. 10,00,000.

= 133.33% X RS . 10,00,000.

= RS. 13,33,3000

Q2. CALCULATE OPERATING , FINANCIAL AND COMBINED LEVERGRS.01. OUTPUT = 15,000 UNITS02. TOTAL OPERATING COST = 3,65,00003. VARIABLE COST PER UNIT = 30% OF SELLING PRICE04. 10% BORROWED CAPITAL = RS. 8,00,00005. SELLING PRICE PER UNIT = RS. 5006. TAX = 40%

Sol :- INCOME STATEMENT

PARTICULARS AMOUNT RS.

SALES( 15,000 X RS. 50 PER UNIT )

7,50,000

LESS : VARIABLE COST ( 30% OF Rs. 50 = 15 X 15,000 )

2,25,000

CONTRIBUTION 5,25,000LESS : FIXED COST

( TOTAL COST – VARIABLE COST i.e 3,65,000 - 2,25,000 )

1,40,000

EBIT 3,85,000LESS : INTEREST ( 10% OF 8,00,000 )

80,000

NPBT 3,05,000LESS : TAX @ 40% 1,22,000

NPAT 1,83,000

(A) OPERATING LEVERAGE : CONTRIBUTION

EBIT

= 5,25,000

3,85,000

= 1.36 Times

(B) FINANCIAL LEVERAGE : EBIT

NPBT

= 3,85,000

3,05,000

= 1.26 Times

(C) COMBINED LEVERAGE : CONTRIBUTION

NPBT

= 5,25,000

3,05,000

= 1.72 Times

Q3. A FIRMS SALES = RS. 75,00,000 , VARIABLE COSTS = RS. 42,00,000 , & FIXED COST = RS. 6,00,000. IT HAS 9% DEBT = RS. 45,00,000 & ITS EQUITY WAS RS. 55,00,000 & TAX = 35%.

01. DEGREE OF OPERATING LEVERAGE.02. DEGREE OF FINANCIAL LEVERAGE.03. COMBINED LEVERAGE04. NEW EBIT IF SALES = RS. 50,00,000.

Sol :- INCOME STATEMENT

PARTICULARS AMOUNT RS.

SALES 75,00,000

LESS : VARIABLE COST 42,00,000

CONTRIBUTION 33,00,000

LESS : FIXED COST 6,00,000

EBIT 27,00,000LESS : INTEREST ( 9% OF 45,00,000 )

4,05,000

NPBT 22,95,000LESS : TAX @ 35% 8,03,250

NPAT 14,91,750

(A) OPERATING LEVERAGE : CONTRIBUTION

EBIT

= 33,00,000

27,00,000

= 1.22 Times

(B) FINANCIAL LEVERAGE : EBIT

NPBT

= 27,00,000

22,95,000

= 1.17 Times

(C) COMBINED LEVERAGE : CONTRIBUTION

NPBT

= 33,00,000

22,95,000

= 1.43 Times

(D) NEW EBIT IF SALES = RS. 50,00,000

CONTRIBUTION = % CHANGE IN EBIT

EBIT % CHANGE IN SALES

1.22 = % CHANGE IN EBIT

50,00,000 - 75,00,000

75,00,000

% CHANGE IN EBIT = ( 25 X 1.22 ) X 100 = 40.66%

NEW EBIT = ( 100 – 40.66% ) x RS. 27,00,000.

= 59.34% X RS . 27,00,000.

= RS. 16,02,180

Q4. CURRENT BALANCE SHEET OF ABC LTD

LIABILITIES AMOUNT RS

EQUITY @ 10 8,00,00010% DEBT 6,00,000RETAINED EARNINGS 3,50,000CURRENT LIABILITIES 1,50,000

TOTAL 19,00,000

ASSETS AMOUNT RS

FIXED ASSETS 10,00,000

CURRENT ASSETS 9,00,000

TOTAL 19,00,000

CURRENT INCOME STATEMENT OF ABC LTD

PARTICULARS AMOUNT RS.

SALES 3,40,000

OPERATING EXPENSES ( INCLUDING DEPRECIATION RS. 60,000)

1,20,000

EBIT 2,20,000

LESS : INTEREST 60,000

EBT 1,60,000

LESS : TAXES 56,000

NET INCOME 1,04,000

(A) DETERMINE ALL LEVERGES.(B) ASSUMING TOTAL ASSETS TO BE THE SAME WHAT WILL BE THE

EPS IF SALES CHANGE BY 20%.

Sol :- INCOME STATEMENT

PARTICULARS AMOUNT RS.

SALES 3,40,000

LESS : VARIABLE COST ( 1,20,000 – 60,000 )

60,000

CONTRIBUTION 2,80,000LESS : FIXED COST

( LESS DEPRECIATION 60,000 )60,000

EBIT 2,20,000LESS : INTEREST ( 10% OF 6,00,000 )

60,000

NPBT 1,60,000LESS : TAX @ 34% 56,000

NPAT 1,04,000

NO. OF EQUITY SHARES 80,000

EPS 1.3 Times

(A) OPERATING LEVERAGE : CONTRIBUTION

EBIT

= 2,80,000

2,20,000

= 1.27 Times

(B) FINANCIAL LEVERAGE : EBIT

NPBT

= 2,20,000

1,60,000

= 1.37 Times

(C) COMBINED LEVERAGE : CONTRIBUTION

NPBT

= 2,80,000

1,60,000

= 1.75 Times

(D) CALCULATION OF EPS

CONTRIBUTION = % CHANGE IN EPS

NPAT % CHANGE IN SALES

2,80,000 = % CHANGE IN EPS

1,04,000 20

% CHANGE IN EPS = 20 X 2.69 = 53.8%

IF SALES INCREASES BY 20%

NEW EPS = 100% + 53.8% = 153.8% X 1.3 = 2.0644 Times

IF SALES DECREASES BY 20%

NEW EPS = 100% - 53.8% = 46.2% X 1.3 = 0.5356 Times

Q5. CURRENT BALANCE SHEET OF ABC LTD

LIABILITIES AMOUNT RS

EQUITY @ 10 60,00010% DEBT 80,000RETAINED EARNINGS 20,000CURRENT LIABILITIES 40,000

TOTAL 2,00,000

ASSETS AMOUNT RS.

FIXED ASSETS 1,50,000CURRENT ASSETS 50,000TOTAL 2,00,000

ASSET TURNOVER = 3

FIXED COST = RS. 1,00,000

VARIABLE COST = 40%

TAXES = 35%

(A) ALL LEVERGES.

Sol :- INCOME STATEMENT

PARTICULARS AMOUNT RS.

SALES { 3 = SALES/2,00,000 } 6,00,000

LESS : VARIABLE COST ( 40% OF 6,00,000 )

2,40,000

CONTRIBUTION 3,60,000LESS : FIXED COST 1,00,000

EBIT 2,60,000LESS : INTEREST ( 10% OF 80,000 )

8,000

NPBT 2,52,000LESS : TAX @ 35% 88,200

NPAT 1,63,800

NO. OF EQUITY SHARES 6,000

EPS 27.3 Times

(A) OPERATING LEVERAGE : CONTRIBUTION

EBIT

= 3,60,000

2,60,000

= 1.38 Times

(B) FINANCIAL LEVERAGE : EBIT

NPBT

= 2,60,000

2,52,000

= 1.03 Times

(C) COMBINED LEVERAGE : CONTRIBUTION

NPBT

= 3,60,000

2,52,000

= 1.42 Times

Q6. THE BALANCE SHEET OF T LTD ON 31.03.2008 IS AS UNDER (LACS)

LIABILITIES AMOUNT RS

EQUITY CAPITAL @ RS.10 9010% DEBT 120RETAINED EARNINGS 30CURRENT LIABILITIES 60TOTAL 300

ASSETS AMOUNT RSBUILDING 150MACHINERY 75STOCK 50DEBTORS 20CASH 5

TOTAL 300

THE TOTAL ASSETS TURNOVER IS 3 , FIXED COST IS 1/6TH OF SALES AND VARIABLES COSTS ARE 50% OF SALES. TAX = 35%

CALCULATE

(A) ALL LEVERAGES(B) THE MARKET PRICE OF THE SHARES IF THE P/E RATIO IS 2.5 TIMES

Sol :- INCOME STATEMENT

PARTICULARS AMOUNT RS.( IN LAKHS)

SALES { 3 = SALES/ 300 } 900

LESS : VARIABLE COST ( 50% OF 900 )

450

CONTRIBUTION 450LESS : FIXED COST ( 1/6TH OF 900 )

150

EBIT 300LESS : INTEREST ( 10% OF 120 )

12

NPBT 288LESS : TAX @ 35% 100.8

NPAT 187.2

NO. OF EQUITY SHARES 9

EPS 20.8 Times

P/E 2.5 Times

MARKET PRICE 52

(A) OPERATING LEVERAGE : CONTRIBUTION

EBIT

= 450

300

= 1.5 Times

(B) FINANCIAL LEVERAGE : EBIT

NPBT

= 300

288

= 1.04 Times

(C) COMBINED LEVERAGE : CONTRIBUTION

NPBT

= 450

288

= 1.56 Times

CASE STUDY

A COMPANY HAS ASSESTS OF RS. 10,00,000 FINANCED WHOLLY BY EQUITY SHARE CAPITAL. THERE ARE 10,00,000 SHARES OUTSTANDING WITH A BOOK VALUE OF RS. 10 PER SHARE. LAST YEAR’S PROFIT BEFORE TAXES WAS RS. 2,50,000. THE TAX RATE IS 35 PER CENT. THE COMPANY IS THINKING OF AN EXPANSION PROGRAMME THAT WILL COST RS. 5,00,000 THE FINANCIAL MANAGER CONSIDERS THE THREE FINANCING PLANS :

(I) SELLING 50,000 SHARES AT RS. 10 PER SHARE

(II) BORROWING RS. 5,00,000 AT AN INTEREST RATE OF 14 PER CENT

(III) SELLING RS. 5,00,000 OF PREFERENCE SHARES WITH A DIVIDEND RATE OF 14 PER CENT.

THE PROFIT BEFORE INTEREST AND TAX ARE ESTIMATED TO BE RS. 3,75,000 AFTER EXPANSION.

CALCULATE :

(I) THE AFTER-TAX RATE OF RETURN ON ASSET,(II) THE EARNINGS PER SHARE (III) THE RATE OF RETURN ON SHAREHOLDERS EQUITY FOR EACH

OF THE THREE FINANCING ALTERNATIVES. ALSO SUGGEST WHICH ALTERNATIVE SHOULS BE ACCEPTED BY THE FIRM.

SOL :-

PARTICULARS PLAN - I PLAN - II PLAN - III

EQUITY DEBT PREF. SHARES

EBIT 3,75,000 3,75,000 3,75,000

LESS: INTEREST - ( 70,000 ) -

EBT 3,75,000 3,05,000 3,75,000

LESS: TAX @ 35% ( 1,31,250 ) ( 1,06,750 ) ( 1,31,250 )

NPAT 2,43,750 1,98,250 2,43,750

LESS: PREFERENCE DIV. - - ( 70,000 )

RETAINED EARNINGS 2,43,750 1,98,250 1,73,750

NO. OF EQUITY SHARES 1,50,000 1,00,000 1,00,000

EPS 1.63 1.98 1.74

COMMENT :

AS THE EPS IN PLAN – II IS HIGHEST THAN OTHER PLANS , ITS PREFERABLE TO GO WITH PLAN-II i.e

“BORROWING RS. 5,00,000 AT AN INTEREST RATE OF 14 PER CENT”