Q.6.

The
operating income ot Hypothetical Ltd amounts to 1,86,000. It
pays 35 per cent tax on its income. Its capital structure consists of the
following
14%Debentures 75,00,000
15% Preference shares
1,00,000
shares R 100 each)
Equity 74,00,000
Determine the firm's EPS. T
i.
Determine the percentage change in EPS associated with 30 per cent
.
change (both increase and decrease) in EBIT

ii. Determine the degree of financial leverage at the current level of EBIT.

iv. What additional data do you need to compute operating as well as

combined leverage?

Solution
Particulars (a) EBIT increases EBIT decreases by
by 30% 30%
EBIT 1,86,000| 2,41,800 1,30,200
-) Interest (5,00,000x 14%)
(70.000) (70.000) (70.000)
EBT 1,16,000 1,71,800 60.200
(-) Tax@ 35% (40,600 60,130) (21.070)
EAT
75,400 1,31,200 39,130
-)Preference dividend 15.000 15.000 15.000
Net Profit Available to equity 60,400 96,670 24,130
shareholders
No. of Equity Shares
4,000 4,000 4,000
EPS= Net Profit
equity 15.1Pershare
Available to 24.17 per share 6.03 per share
shareholders/ No. of Equity Shares
%change in EPS
new-old x100 24.17-15.1 x 100
old 100 6.03-15.1100
15.1 15.10
= 60% = - 60%

C.DFL EBIT 1,86,000

EBT =
1.6 times
1,16,000
d. The comp
npany requires contribution to calculate operating as well as financial
leverage
Q.7 Calculate
ulate operating, financial and combined leverages under
ations when fixed costs are (a) 5,000 (b) 7 10,000and financial
Plans 1 and
2, from the following information
peration and capital structure of X2 Ltd. pertaining to
 Total assets F 30,000
Total assets turnover based on sales 2

Variable costs as percentage of sales 60%

Capital structure: Financial plans
1 2

30,000 710,000
Equity
10% Debentures 10,000 30,000

Solution
Sales
Asset Turnover Ratio =

Total Assets

2
Sales Sales 60,000
30,000
Particulars Plan 1 Plan 2

FC= 5,000 FC-10,000 2FC= T5,000 FC=10,000

Sales 60,000 60,000 60,000 60,000

(-)Variable Cost (36,000) (36,000) (36,000) (36,000)
Contribution 24,000 24,000 24,000 24,000
(-) Fixed Cost (5,000) (10,000) (5,000) (10,000)
EBIT 19,000 14,000 19,000 14,000
(-) Interest (1,000) (1,000) (3,000) (3,000)
EBT 18,000 13,000 16,000 11,000
DOL = C
EBIT 24,000 24,000 24,000 24,000
19,000 14,000 19,000 14,000
=
1.26 = 1.71
= 1.71
1.26
DFL = EBIT 19,000 14,000 19,000 14,000
EBT 18,000 13,000 16,000 11,000
=1.06 = 1.08
1.19 1.27
DCL DOL x DFIL 1.26 x 1.06 1.71 x 1.08 1.19 x 1.26 1.71 x 1.2
= 1.34 = 1.85
1.50 2.17
1 1 The ABC Ltd. has the following balance sheet and income staternent
information:

Balance sheet s on March 31,2015

Liabilities Assets
Equity capital (R 10 per 8,00,000 Net fixed assets 10,00,000
share Current assets 9,00,000
10% debt 6,00,000
Retained earnings 3,50,000
Current liabilities 1,50,000
19,00,000 19,00,000
Income statement for the year ending March 31, 2015
Sales 3,40,000
Operating expenses (including Rs 60,000 depreciation) 1,20,000
EBIT 2,20,000
Less: interest 60,000
Earning before tax 1,60,000
Less: Taxes 56,000
Net earnings (EAT)
1,04,000
a) D the of operating, financial and combined leverage at the
degree
S a l e s level, if all operating expenses, other than depreciation, are
variable costs.
(D) It total assets remain at the same level, but sales (i) increase by 20 per
and (ii) decrease by 20 per cent, what will be the eamingS per share in cen
the
new situation and percentage change in EPS.

Solution:
(a) (b)
Particulars
Sales increases Sales
by 20%
decreases by
20%

Sales 3,40,000 4,08,000 2,72,000

(-)Variable Cost (60,000) (72,000) (48,000)
Contribution 2,80,000 3,36,000 2,24,000
(-)Fixed Cost 60.000) (60.000) 60.000)
EBIT 2,20,000 2,76,000 1,64,000
(-) Interest 60.000) (60.000) 60.000)
EBT 1,60,000 2,16,000 1,04,000
(-) Tax @ 35% (56.000) (75,600) 36,400)
EAT 1,04,0000 1,40,400 67,600
Pref. Dividend
Net Profit available for equity 1,04,000 1,40,400 67,600
share holder
No. of equity share 80,000 80,000 80,000
EPS Net profit available
=

for| 1.3 per share 1.76 per

share 0.85 per share
equity share/ No. of equity share % change in EPS %change in
EPS
C 2,80,000
DOL EBIT 1.76-1.30 0.85-1.30
2,20,000 1.30 1.30
=1.27 times x100 100
DFL T EBT 2,20,000 35% = -35%
1,60,000
1.38 times
=1.27x1.38
DCL DOL x DFL 1.75 times
Q12. The WellEstablished company's most recent balance sheet is followS
Liabilities Amoumt Assets Amount

Equity capital (7 10 per share) 60,000 Net fixed assets 1,50,000

10% long- term debt
80,000 Curent assets 50,000
Retained earnings 20,000
Current liabilities 40,000
Total 2,00,000 Total 2,00,000
 The company' nany's total assets turnover ratio is 3, its fixed
operating costs are
1 , 0 0 , 0 0 0
he variable operating costs ratio is 40 per cent.
The income tax
cent.
35 per
rate is
Calculate all the three types of leverages

Detemine the likely level of EBIT if EPS is (i) 71, (i) 7 3, and (ii) Zero
b
Solution

Particulars

Sales 6,00,000
(-)Variable Cost (2,40,000)
Contribution 3,60,000
(-)Fixed Cost (1,00,000)
2,60,000
EBIT
(-) Interest (8,000)
2,52,000
EBT
(88,200)
(-)Tax 1,63,800
EAT
3,60,000
C 2,60,000
DOL EBIT =1.38
times

EBIT 2,60,000
DFL EBT 2,52,000
=1.03
times
DCL = DOL x DFL 1.38 x
1.03= 1.42
times

(b

)(i) EPS
EPS EBIT-Int) (1 -Tax)-Pref. dividend
No. of Equity Shares

-8,000) (1-0.35)-0
6,000

6,000 0.65 (x- 8000)

6000 =0.65x- 5200
11,200 0.65 x
X= 17,230
 Q14: From the following prepare income statement of company LYNCH and

GLOBAL
Particulars LYNCH GLOBAL
Financial leverages 4
Interest 20,000 30,000
5 6
Operating leverages
Variable cost as % of sales 66 % 75
Tax rate (%) 35 35
(BMS Mumbai University)
Solution
Income Statements
Particulars LYNCH GLOBAL
Sales 4,50,000 9,60,000
(-)Variable Cost (3,00,000) (7,20,000)
Contribution 1,50,000 2.40,000
(-)Fixed Cost (1,20,000) (2,00,000)
EBIT 30,000 40,000
-)Interest (20,000) (30,000)
EBT 10,000 1,000
(-)Tax@ 35% (3,500) (35,00)
EAT 6,500 6,500

Working Note
LYNCH
GLOBAL
DFL EBIT
EBT EBIT
EBIT
DFL-EBT
DFL EBT Int. EBIT
DFL= EBT Int. -

3 =
EBIT
EBIT 20,000 4 EBIT
EBIT 30,000
3 (EBIT 20,000) EBIT
3 EBIT-60,000 = EBIT 4 (EBIT-30,000)= EBIT
3 EBIT-EBIT = 60,000
4 EBIT 1,20,000 EBIT =

3 EBIT = 1,20,000
2 EBIT =
60,000
EBIT 2,20,000
EBITO0,000
3
2 EBIT = 40,000D
EBIT = 30,000
DOL C C
C C EBIT = 6 x
DOL = EBIT =
5 x
30,000 EBIT
40.000
40,000
C =5 x30,000= 1,50,000 C =6 x 40,000= 2,40,0000
KFrom the following particulars, prepare income statement of A Ltd. and B.
Ltd.
A Ltd. B Ltd.
Degree of Combined Leverage 6 times 15 times
Degree of Operating Leverage 3 times 5 times
Variable Cost as a % of Sales 40% 50%
Rate of Income Tax 35% 35%
Number of Equity Shares 1,00,000 1,00,000
Earmings Per Share 1.30 0.65
(BMS Mumbai University)
Solution:
Income Statement

Particulars A Ltd B Ltd

Sales 20,00,000 (100%) 30,00,000 (100%)
(-) Variable Cost (8.00.000) 40%) (15.00.000 150%)
Contribution 12,00,000 (60%) 15.00.000 150%)
(-)Fixed Cost (8.00.000) 12.00.000)
EBIT 4,00,000 3,00,000
(-) Interest (2.00.000 (2.00,000)
EBT 2,00,000 1,00,000
(-) Tax @ 35% (70,000) 135.000)
EAT 1,30,000 6,50,0000
Working Note:
A Ltd B Ltd

(1) EPS NPAT NPAT

=
No. of equity share (1) EPS No. of equity share
1.3 NPAT NPAT
1,00,000 0.65 1,00,000
NPAT 1,30,000 NPAT = 6,50,000
(2) DCL =DOL x DFL (2) DCL = DOL x DFL
6 3 x DFL 15 = 5 x DFL
DFL 2 DFL = 3

DFL EBIT
EBT EBIT
DFL
EBT
2 EBIT EBIT
2,00,000 3- 1.00,000
EBIT = 4,00,000
EBIT3,00,000
DOL =Contribution
EBIT (3) DOL Contribution
EBIT
3 COntribution 5 Contribution
4,00,000 3,00,0000
Contribution =12,00,0000 Contribution = 15,00,000
Q16
Particulars
Company A Company B
56,000 60% of sales
Variable cost
20,000
Fixed Cost
12,000 9,000
Interest expenses
5:1
Financial Leverages
Operating Leverages 4.1
30% 30%
Income tax rate

Sales
10,05,000
Solution:
Particulars
Company A Company B

Sales
91,000 1,05,000
(-)Variable Cost 56,000 63.000
Contribution 35,000 42,000
-: Fixed Cost 20.000 31.000
EBIT 15,000 10.500
() Interest 12.000 9.000
EBT 3,000 1,500
(-)Tax@ 30% 900 450
EAT 2,100 1.050
wORKING NOTES
CompanyA
EBIT
Financial Leverages
EBIT INTEREST
5 EBIT
EBIT -12,000

5 (EBIT-12,000) = EBIT
5 EBIT 12,000 = EBIT
4 EBIT = 60,000

EBIT=15,000
ii) Contribution =EBIT + Fixed Cost 15,000+20,000 35,000 =

ii) Sales Contribution +Variable Cost 35,000+56,000 91,000

=
=

Q17: A firm has sales of 75,00,000 variable cost of 42,00,000 and tiv
cost of 6,00,000. It has debt of 7 45,00,000 at 9%. And equity of
a

55,00,000
1. What is the fim RO
2. Does it have favorable financial leverage.
 Levere

If the firm belongs to an industry whose asset turnover is 3, does it have

3
high or low asset leverage

4. What are operating, financial and combined leverage of the firm?

5.
Ifsales drop to 50,00,000 what will be the new EBIT?
A t what level of sales the EBT of the firm will be equal to zero?

(BMS Mumbai University)

Solution
NPBIT
ROI Capital Employed x 100

Particulars Rs
Sales 75,00,000
(-) Variable Cost 42,00,0000
Contribution 33,00,000o
(-)FixedCost 6,00,000
NPBIT 27,00,0000
1
27,00,000 X 100 27%
55,00,00,000 + 45.00.000
=

no
2 The company has a favourable financial leverage since the ROI of 27% is
greater than the cost of debt of 9%.

3 Sales
Asset turnover/ Asset Leverag= Total 75,00,000
Assets =100.00.000 . />umes

The asset turnover ratio of the industry is 3 times but the asset turnover ratio
of the company is 0.75 times. Therefore, the company is not effectively
utilizing the assets to generate sales.
4.
Particulars Rs.
Sales 75,00,000
(-)Variable Cost 42.00.000
Contribution 33.00,000
(-)Fixed Cost 6.00.000
EBIT 27,00,000
(-) Interest (9% on 45 lac) 4.05.000
EBT 22,95,000

. DOL=
DOL = Contribution 33,00,000
27,00,000 1.22
EBIT

EBIT 27,00,000
DFLEBT 92,96,0001.18

DCL =
DOL x DFL =
1.22 x 1.18 1.43
5)
Particulars
Sales
50,00,000
(-)Variablecost (28.00.000)
Contribution
22,00,000
(-) Fixed cost
EBIT
6.00.000
16,00,000
6)
Particulars
Sales 22,84,090
(-) Variable cost
12,79.090
Contribution 10,05,000
(-) Fixed cost
6.00.000
EBIT 4.05,000
( Interest 14.05.000
EBT
(0)