3.

PART A - LEVERAGE

MEANING OF LEVERAGE:
The concept of leverage has its origin in science. It
means influence of one over another.
In the context of financial management, the term
‘leverage’ means sensitiveness of one financial variable
to change in another. Use of one financial variable to
create an impact on other financial variable
For example
4 Increase in sales leads to increase in EBIT.
4 Increase in EBIT leads to increase in EPS.
The term leverage in general, refers to advantage gained
for any purpose

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What is advantage
TYPES OF LEVERAGE

Types of leverage

Operating leverage Financial leverage Combined leverage

FIXED COSTS

Fixed cots

Operating fixed cost e.g. Financial fixed cost e.g.,

salary, insurance, rent, etc. interest, preference dividend.

Financial fixed cost e.g., interest, preference dividend.

Particulars Rs.
Sale
-Variable cost
--------------------
Contribution
- Fixed cost
--------------------
EBIT
-interest
------------------
EBT
-tax

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 Part A - Leverage

-------------------
PAT
- dividend to PS
-----------------
Earning available for ESH
No
EPS

OPERATING LEVERAGE :
a) Definition: operating leverage is defined is defined as the “firm’s ability to use
fixed operating costs to magnify effects of changes in sales on its earnings before
interest and taxes.”

b) Explanation: a change in sales will lead to a change in profit i.e. earnings before
interest and taxes (EBIT). The effect of change in sales on EBIT is measured by
operating leverage. Since fixed costs remain the same irrespective of level of output,
percentage in EBIT will be higher than increase in sales.

c) Measurement : The degree of operating leverage (DOL) is measured by (expressed

in times)

% change in EBIT or contribution

% change in sales EBIT

d) Significance:
§ Effect on EBIT: DOL measures the impact of change in sales on operating income.
Suppose DOL of a firm is 1.67 times, it implies that 1% change in sales will lead to

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1.67% change in EBIT. Hence, if sales increases by 20%, EBIT increases by 20%
×1.67 = 33%. Also, if sales decreases by say 40% , EBIT falls by 67%
§ Impact of fixed costs: DOL depends on fixed costs. If fixed costs are higher,
DOL is higher and vice-versa.
§ Effect of high DOL: if DOL is high, it implies that fixed costs are high, Due
to the high, hence the break even pint (no profit – no loss situation) would be
reached at a higher level of sales. Due to the high break-even point, the margin
of safety and profits would low. This means that the operating risks are higher
hence a low DOL is preferred.
§ A high DOL means that profits (EBIT) may be wiped off. Even for a marginal
reduction in sales. Hence it is preferred to operate sufficiently above break-even
point to avoid the danger of fluctuations in sales and profits.

e) Operating breakeven point = fixed cost fixed cost

or
contribution per unit PV ratio

Important points about operating leverage
1) DOL is undefined at break – even point.
2) DOL is negative below break – even point.
3) DOL is positive above break –even point.
4) DOL decrease as sales increases, because risk reduces.
5) Each level of sales has different operating leverage

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FINANCIAL LEVERAGE :
a) Meaning: financial leverage is defined as the ability of a firm to use fixed financial
charges (interest) to magnify the effect of changes in E.B.I.T/ Operating profits on
the firm’s earning per share (EPS).

b) Explanation: financial leverage occurs when a company has debt content in its
capital structure and fixed financial charges e. g. interest on debentures. These
fixed financial charges do not vary with the EBIT. They are fixed and are to be
paid irrespective of level of EBIT. Hence an increase in EBIT will lead to a higher
percentage increase in earnings per share (EPS). This is measured by the financial
leverage.

c) Measurement : the degree of financial leverage (DFL) is measured by : (expressed

in times)

DFL = % change in EPS

% change in EBIT
= EBIT
EBT …… it is used when there are no preference shares

= EBIT
EBIT-INT-1-tax
PREF.div
rate
… used when there are preference shares

d) Significance:
§ Effect on EPS: DFL measures the impact of change in EBIT (operating income)
on EPS (earnings per share).supposes DFL of a firm is 4 times, it implies that 1%
change in EBIT will lead to 4% change in EPS. Hence, if EBIT increases by 10% EPS
increases by 10% × 4= 40%. Also, if EBIT decreases by say 5% EPS, fall by 20%

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Indicator of financial risk

e) Impact of fixed financial charges:
DFL depends on the magnitude of interest and fixed financial charges. If these
costs are higher, DFL is higher and vice-versa.
Effect of high DFL: if DFL is high, it implies that fixed interest charges are
high. This means that the financial risks are higher. The DFL is considered to be
favourable or advantageous to the firm, when if earns more on its total investments
that what it pays towards debt capital. In other words, DFL is advantageous only
if return on capital employed (ROCE) is greater than rate of interest on debt.

Financial BEP – it is that level of EBIT at which EPS is zero.

Financial break-even point = PD
1+
1-TAX RATE
Where, I= interest, PD = pref. dividend

Important points about financial leverage :

1) DFL is UNDEFINED AT FIANCIAL BEP.

2) DFL is negative below financial BEP.
3) DFL is positive above financial BEP
4) DFL decreases as EBIT increase, because the risk reduces.
5) Each, level of EBIT has different DFL.
6) When there is no interest and preference dividend, DFL = 1

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WHEN IS A FIRM SAID TO BE FIANCIALLY FAVOURABLY LEVERAGED :

To determine whether the degree of financial leverage is favourable or not, the return
on capital employed (ROCE) should be compared with rate of interest on debt.

1) When ROCE greater than interest rate:

DFL is considered to be favourable or advantageous to the firm, when it earns more
on its to total investment than what is pays towards debt capital. In other words.
DFL is advantageous only if return on capital employed (ROCE) is greater than rate
of interest on debt.
This is because shareholders gain in a situation where the company earns a high rate
of return and pays a lower rate of return to the supplier of long term debt funds.
Financial leverage in such cases is therefore also called trading on equity.
The difference, between the return (EBIT) and the cost of the debt funds would
enhance the earnings of shareholders. Further, in case of debt funds the interest
cost also tax deductible.

2) When ROCE is less than interest rate:

Where the rate of return on investment falls below the rate of interest the
shareholders suffer because their earnings fall more sharply than the fall in the
return on investment. This is because fixed interest costs have to be met, irrespective
of the level of EBIT. In such cases, a high DFL is disadvantageous; in fact, the use
of debt funds involving fixed commitment of interest rate on debt, DFL should be
maintained low.

3) Conclusion: DFL should be high when return on capital employed (ROCE) is greater
than interest rate on debt, if ROCE is less than interest rate on debt, DFL should
be maintained low.

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COMBINED LEVERAGE :
a) Meaning: combined leverage is used to measure the total risk of a firm i.e.
operating risk and financial Risk.

b) Explanation: effect of fixed operating costs (i.e. operating risks) is measured by

operating leverage (DOL). Effect of fixed interest charges (i.e. financial risks) is
measured by financial leverage (DFL). The combined effect of these is measured
by combined leverage (DCL).

c) Measurement : the degree of combined leverage (DCL) is measured as DOL ×

DFL
Therefore,
DCL = contribution
EBT
= Contribution
EBIT-Int- I-tax
pref.Div
rate

d) Significance: DOL measures impact of change in sales on EBIT. DFL measures the
impact of change in EBIT on EPS; DCL measures the combined impact, l.e. effect
of change in sales on EPS. IF DCL is 2 times. It implies that a 10% increase in
sales will lead to 20% increase in EPS.

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PROBLEMS

4 BASIC PROBLEMS :
1. Sales 1,00,000 units @ Rs. 2 per unit
Variable cost per unit = 0.70
Fixed cost = Rs. 1,00,000
Interest = 3,668
Find
a) Degree of operating leverage
b) Degree of financial leverage
c) combined leverage

2. Calculate the degree of operating leverage (DOL), degree of financial leverage (DFL)
and the degree of combined leverage (DCL) for the following firms and interpret the
results.

Firm A Firm B Firm C

1) Output (units ) 60, 000 15, 000 1, 00, 000
2) Fixed costs (Rs.) 7, 000 14, 000 1, 500
3) Variable cost per unit (Rs.) 0.20 1.50 0.02
4) Interest on borrowed funds (Rs.) 4, 000 8, 000 -
5) Selling price per unit (Rs.) 0.60 5.00 0.10

3. A firm sells its products for Rs. 60 per unit, has variable operating costs of Rs. 40
per unit and fixed operating costs of Rs. 7,000 per year. Its current level of sales is
400 units. Determine the degree of operating leverage. What will happen to EBIT if
sales change: (a) rise to 480 units, and (b) decrease to 300 units?

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4. The data of two firms Rama and Krishna, having the same PV ratio, is given
below. Make relevant computations and comment on their operating risks.

Particulars Rama Krishna

Less : Sales Rs. 2,00,000 Rs. 2,00,000
Variable Cost Rs. 1,20,000 Rs. 1,20,000
Less : Contribution Rs. 80,000 Rs. 80,000
Fixed Costs Rs. 30,000 Rs. 50,000
Profit Rs. 50,000 Rs. 30,000

5. A firm has sales of 10, 00, 000 variable cost of Rs. 7, 00, 000 and fixed cost
of Rs. 2, 00, 000 and debt of Rs. 5, 00, 000 at 10% rate of interest. What are
the operating, financial and combined leverages? If the firm wants to double its
earnings before interest and tax (EBIT), how much of a rise in sales would be
needed on a percentage basis?

6. A firm has sales of Rs. 50 Lakhs, Variable costs of Rs. 35 Lakhs, Fixed Cost of Rs.
7 lakhs, 10% Debt of Rs. 30 Lakhs, and Equity Capital of Rs. 55 Lakhs. Calculate
Operating and Financial leverage.

7. Compute the combined leverage from the following data – (a) EBIT = Rs.
10,00,000 (b) Fixed costs = Rs. 20,00,000 and (c) EBT = Rs. 8,00,000.

8. The following information is available for ABC& co.

EBIT Rs. 11, 20, 000
Profit before tax 3, 20, 000
Fixed costs 7, 00, 000
Calculate % change in EPS if the sales are expected to increase by 5%

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9. X Corporation has estimated that for a new product its break-even point is 2,000
units if the item is sold for Rs. 14 per unit; the cost accounting department has
currently identified variable cost of Rs. 9 per unit. Calculate the degree of operating
leverage for sales volume of 2, 500 units and 3,000 units. What do you infer from
the degree of operating leverage at the sales volumes of 2,500 units and 3, 000 units
and difference if any?

10. Consider the following data for Omega Ltd: EBIT = Rs. 15,750 Lakhs, EBT = Rs.
7,000 Lakhs and Fixed Operating Costs = Rs. 1,575 Lakhs. Calculate Percentage
change in EPS, if sales increase by 5%.

11. Arun Ltd sells 2000 units at Rs. 10 per unit. Its variable costs ratio is 70% and
fixed cost is Rs. 1000. The company had raised the required funds by issue of 100,
10% Debentures at Rs. 100 each and 2000 equity shares at Rs. 10 per share. The
company’s sales are expected to increase by 20%. Assuming a tax rate of 50%, find
out the impact of increase in sales on its EPS.

12. The share capital of a company is Rs. 10,00,000 with shares of face value of Rs. 10.
The company has debt capital of Rs. 6,00,000 at 10% rate of interest. The sales
of the firm are 3,00,000 units per annum at a selling price of Rs. 5 per unit and
the variable cost is Rs. 3 per unit. The fixed cost amounts to Rs. 2,00,000. The
company pays tax at 35%. If the sales increase by 10%, calculate :-
(i) Percentage increase in EPS;
(ii) Degree of operating leverage at the two levels; and
(iii) Degree of financial leverage at the two levels.

13. A company has annual sales of Rs. 1 lakh with 60% contribution margin. The fixed
operating costs are Rs. 30,000 and the interest on Long-term debt is Rs. 10,000.

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Compute the combined leverage and find its impact on residual income is sales
increase by 5%.

PROBLEMS OF MISSING VALUE :

14. The following details of Alpha Ltd. for the year ended 2010 are furnished :
Financial Leverage 2:1
Operating leverage 3:1
Interest charges per annum Rs. 20 lakh
Corporate tax rate 40%
Variable cost as percentage of sales 60%

15. Particulars A B C
Variable cost as 66.666 75 50
% of sales
Interest expense 200 300 1000
DOL 5 6 2
DFL 3 4 2
Tax rate 35% 35% 35%

Prepare income statement for the company A , B & C.

16. From the following prepare income statements of A,B and C. briefly comment on
each firms performance :

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 Part A - Leverage

Firm a Firm B Firm C

Financial leverage 3:1 4:1 2:1
Interest 200 300 1, 000
Operating leverage 4:1 4:1 4:1
Variable cost as a % of sales 66.67% 75% 50%
Income – tax rate 45% 45% 45%

17. Balance sheet of ABC ltd is given below :

Liability Rs. Asset Rs.

Equity share capital ( Rs. 10 each) 60,000 Net fixed asset 1,50,000
10% long term debt 80,000 Current asset 50,000
Retained earning 20,000
Current liability 40,000

Company’s total asset turnover ratio is 3. Its fixed operating cost are Rs. 1,00,000.
Variable cost ratio is 40 %. Tax rate is 35%.
a) Calculate all type of leverage
b) Determine likely level of EBIT if EPS is i) Rs.1 ii) Rs. 3 iii) zero

18. The balance sheet of alpha numeric company is given below:

Liabilities Amount Assets Amount

Equity capital (Rs.10 per share) Rs. 90, 000 Fixed assets Rs. 2,25, 000
Retained earnings 30, 000 Current assets 75, 000
10% Debt 1, 20, 000
Current 60, 000
3, 00, 000 30, 00, 000

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The company’s total assets turnover ratio is 3, its fixed operating cost is Rs. 1, 50,
000 and its variable operating cost ratio is 50%. The income – tax rate is 50%
You are required to:
i) Calculate the different type of leverage for the company
ii) Find put of the EBIT if EPS is (a) Re, (b) Rs.2(c) Re.0

19. A firm’s total costs are totally variable. You are required to answer the following
– (a) What is DOL? (b) What will happen to EBIT if sales increases by 100%
and if sales fall by 50% (c) What is the condition for the firm incurring losses?

20. X Ltd has estimated that for a new product its break-even point is 2,000 units if
the items is sold for Rs. 14 per unit; the cost accounting department has currently
identified variable cost of Rs. 9 per unit. Calculate the degree of operating leverage
for sales volume of 2,500 units and 3,000 units.

21. From the following data of company A and Company B, prepare their Income
statements.

Particulars Company A Company B

Variable costs Rs. 56,000 60% of sales
Fixed costs Rs. 20,000 ?
Interest Expenses Rs. 12,000 Rs. 9,000
Financial Leverage 5:1 ?
Operating Leverage ? 4:1
Income tax rate 30% 30%
Sales ? Rs. 1,05,000

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22. Complete the following statement with the given data:-

Sales ?
Less: Variable costs ?
Contribution ?
Less: Fixed Costs ?
EBIT ?
Less: Income tax ?
EAT ?

PAT = 5% on sales, Income tax rate = 50%, DOL = 4 times, Debt = Nil, Variable
costs = Rs. 3 lakhs.

23. Calculate the EBT and Financial Leverage if Net worth = Rs. 25 Lakhs, Debt/Equity
= 3:1, Interest rate = 12% and operating profit = Rs. 20 Lakhs.

24.
i) Find out operating leverage from the following data:
Sales 50, 000
Variable costs 60%
Fixed costs 12, 000
ii) Find out the financial leverage from the following data:
Net worth Rs. 25, 00, 000
Debt/equity 3:1
Interest rate 12%
Operating profit Rs. 20, 00, 000

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25. Prepare the income statement and balance sheet from the following data:
4 Price-Earning ratio = 3 times
4 Market price per share = Rs. 18
4 No of equity shares of Rs. 10 each = 10,000
4 No of 12% Preference shares of Rs. 100 each = 1,000
4 Degree of financial leverage = 2
4 Degree of operating leverage = 2
4 Income tax rate = 40%
4 Variable cost as % of sales = 60%
4 Rate of interest on debt = 10%

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 Part A - Leverage

1. ………….. is used to measure the sensitivity of one financial variable to change in

another. The measurement of sensitivity of one financial variable to change in
another is called as …………….
a. Financial Variable
b. Operating Leverage
c. Leverage
d. None

2. Match the pair

a. Operating Leverage a. EBIT / EBT
b. Financial Leverage b. DOL x DFL
c. Combined Leverage c. Contribution / EBIT
a. (a-c), (b-a), (c-b)
b. (a-b), (c-a), (b-c)
c. (c-b), (a-c), (b-b)
d. None

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3. Match the pair

1. Operating Variable Cost a. Rent
2. Operating Fixed Cost b. Interest on Debentures
3. Financial fixed cost c. Material
a. (1-b), (2-c) , (3-a)
b. (1-a), (3-c), (2-b)
c. (3-b), (1-c), (2-a)
d. None

4. Which of the following are types of Leverages?

a. Operating Leverage
b. Combined Leverage
c. Financial leverage
d. All of the above

5. Which of the following is operating fixed cost?

a. Salary
b. Interest
c. Preference Dividend
d. All of the above

6. Which of the following is financial fixed cost?

a. Preference Dividend
b. Factory Rent
c. Depreciation of Factory Machine
d. Salary

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 Part A - Leverage

7. Sales = Contribution + …………..

a. Variable Cost
b. Fixed Cost
c. EBIT
d. None.

8. Contribution - ……………= EBIT

a. Interest
b. Variable cost
c. Fixed operating cost
d. None

9. EBIT + Fixed Cost = …………….

a. Variable cost
b. Contribution
c. EPS
d. None of the above.

10. EBIT - ………..= EBT

a. Interest of debentures
b. Dividend to Preference Shareholders
c. Dividend to Equity Shareholders
d. All of the above

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11. EAT + Tax =…………

a. EBIT
b. EPS
c. EBT
d. None

12. Earnings available to equity shareholders = …………. – Preference Dividend

a. Profit after Tax
b. Profit before tax/EBT
c. EBIT
d. None.

13. EBT + Interest =

a. EBIT
b. PAT
c. Contribution
d. None.

14. Identify the correct statement-

a. Fixed cost per unit remain unchanged with change in sales quantity.
b. Fixed Cost per unit increase with increase in sales quantity
c. Fixed cost per unit decrease with increase in sales quantity
d. None

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 Part A - Leverage

15. Identify the correct statement-

a. Variable cost per unit remains unchanged with change in sales quantity
b. Variable cost per unit change with change with in sales quantity.
c. Variable cost per unit increase with increase in sales quantity.
d. None.

16. The Term operating Leverage is defined as ………….

a. The firm’s ability to use fixed operating cost to magnify the effect of change in
sales on its earnings before interest and taxes
b. The firm’s ability to use fixed operating cost to magnify the effect of change in
Fixed operating cost on its earnings before interest and taxes
c. The firm’s ability to use variable operating cost to magnify the effect of change in
Fixed operating cost on its earnings before interest and taxes
d. None.

17. Which of the following is correct Statement?

a. Operating Leverage is defined as the firm’s ability to use fixed operating costs to
magnify effects of change in sales on its earning before interest and taxes.
b. Operating Leverage is defined as the firm’s ability to use fixed operating costs to
magnify effects of change in sales on its earning after interest and taxes.
c. Operating Leverage is defined as the firm’s ability to use fixed financial costs to
magnify the effects of change in sales on its earning before interest and taxes.
d. All of the above are correct.

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18. When operating fixed cost is zero, explain the impact on degree of operating
leverage-
a. DOL will be zero
b. DOL will be 1
c. DOL will be nil
d. None

19. The effect of change in Sales on EBIT is measured by …………………

a. Operating Leverage
b. Financial Leverage
c. Combined Leverage
d. None

20. Which of the following is correct statement?

a. The percentage of change in EBIT is always higher than percentage of change in
sales.
b. The percentage of change in EBIT is always lower than percentage of change in
Sales.
c. The percentage of change in EBIT is always equal to percentage of change in
sales.

21. The degree of operating leverage is measured by

a. % Change in EBIT / % change in Sales.
b. Contribution / EBIT
c. % Change in EBT / % Change in Sales.
d. A & B

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 Part A - Leverage

22. What it implies if DOL is 2 times-

a. If 1% change in sales will lead to 2% change in EBIT.
b. If 2% change in sales will lead to 2% change in EBIT.
c. If 1% change in sales will lead to 1% change in EBIT.
d. All of the above.

23. The financial leverage is defined as –

a. The ability of firm to use fixed financial cost to magnify the effect of change in
EBIT on earning per shares.
b. The ability of firm to use fixed operating cost to magnify the effect of change in
EBIT on earning per shares.
c. The ability of firm to use fixed financial cost to magnify the effect of change in
EBIT on earning before tax.

24. The financial leverage occurs when company has …………… content in its capital
structure and …………… financial charges.
a. Debt, Variable
b. Equity, Fixed
c. Debt, Fixed
d. Equity, Variable

25. Identify the correct statement

a. Fixed financial charges vary with change in EBIT
b. Fixed financial charges remains constant even though there is change in EBIT
c. Fixed financial charges do not vary with EBIT.
d. None

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26. DFL is measured by …………. (When there is no preference share)

a. % changes in EPS / % change in EBIT.
b. EBIT/ EBT
c. EBT/ EBIT
d. a & b

27. If DFL is 4 times, what it implies-

a. 1% changes in EBIT will lead to 4% changes in EPS.
b. 4% change in EBIT will lead to 1% changes in EPS.
c. 4% change in sales will lead to 1% change in EPS.
d. None.

28. Identify correct statement -

a. Financial leverage is considered as indicator of financial risk.
b. Operating leverage is considered as indicator of financial risk.
c. Combined leverage is considered as indicator of financial risk.
d. all of the above

29. Explain the reason of if there is increase in EBIT will lead to higher percentage
increase in earning per share.
a. Fixed financial charges vary with the EBIT, they change with change in level of
EBIT
b. Fixed financial charges do not vary with EBIT, They are fixed irrespective level of
EBIT
c. Fixed financial charges increases with increase in level of EBIT
d. None.

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 Part A - Leverage

30. DLF is higher if-

a. Fixed financial cost is higher
b. Fixed financial cost is lower
c. Fixed operating cost if lower
d. None

31. If DFL is higher, what it implies-

a. It means fixed financial cost is higher hence financial risk is higher
b. It means fixed financial cost is lower hence financial risk is low.
c. It means fixed financial cost is lower hence financial risk is higher.
d. None.

32. Identify the correct statement-

a. Financial BEP means It is that level of EBIT at which EPS is Zero.
b. Financial BPE is undefined at all level of EBIT.
c. Degree of financial leverage is always negative
d. None

33. When there is no interest and preference dividend –

a. DFL = 1
b. DFL = 0
c. DFL= -1
d. None

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34. Combined leverage is used to measure the –

a. Financial Risk
b. Operating Risk
c. Operating and Financial Risk
d. None.

35. How DCL is calculated-

a. EBIT/ Contribution
b. Contribution / EBIT
c. Contribution / EBT
d. None

36. DCL measures the effect of-

a. Change in sale on EPS
b. Change in sale on EBIT
c. Change in EBIT on EPS
d. None.

37. Sales 1,00,000 Units @ Rs.2 per unit

Variable cost per unit = 0.70
Fixed Cost= Rs. 1,00,000
Interest= 3,668
Find
a. Degree of operating leverage-
a. 4.55 b. 4.33 c. 4.94 d. 4.88

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 Part A - Leverage

38. Sales 1,50,000 Units @ Rs.2 per unit

Variable cost per unit = 0.50
Fixed Cost= Rs. 80,000
Find Degree of operating leverage
a. 6 b. 2 c. 5 d. None

39. Sales 1,50,000 Units @ Rs.2 per unit

Variable cost per unit = 0.50
Fixed Cost= Rs. 80,000
Interest= 5,000
Find-
a) Degree of financial leverage-
a. 1.04 b. 1.15 c. 0.96 d. None

40. Sales 1,00,000 Units @ Rs.2 per unit

Variable cost per unit = 0.70
Fixed Cost= Rs. 1,00,000
Interest= 3,668
Find:- Degree of financial leverage-
a. 2 b. 3 c. 1.14 d. None

41. Sales 1,00,000 Units @ Rs.2 per unit

Variable cost per unit = 0.70
Fixed Cost= Rs. 1,00,000
Interest= 3,668
Find-
a) Combined leverage
a. 4.94 b. 3.96 c. 4.33 d. None.

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42. Sales 1,50,000 Units @ Rs.2 per unit

Variable cost per unit = 0.50
Fixed Cost= Rs. 80,000
Interest= 5,000
Find Combined leverage
a. 2 b. 3 c. 4 d. None.

43. A firm sells its products for Rs. 60 per unit, has variable operating costs of Rs. 40
per unit and fixed operating costs of Rs. 7,000 per year. Its current level of sales
is 400 units. Determine the degree of operating leverage.
a. 8 b. 8.33 c. 7 d. None

44. A firm sells its products for Rs. 80 per unit, has variable operating costs of Rs. 50
per unit and fixed operating costs of Rs. 7,000 per year. Its current level of sales
is 400 units. Interest cost is 4,000. Determine the degree of financial leverage.
a. 4 b. 12 c. 5 d. None

45. A firm sells its products for Rs. 60 per unit, has variable operating costs of Rs. 40
per unit and fixed operating costs of Rs. 7,000 per year. Its current level of sales
is 400 units. What will happen to EBIT if sale rise to 480 units?
a. EBIT will increase by the Rs. 1600
b. EBIT will decrease by Rs. 1600
c. EBIT will decrease by Rs. 1000
d. None

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 Part A - Leverage

46. A firm sells its products for Rs. 60 per unit, has variable operating costs of Rs. 40
per unit and fixed operating costs of Rs. 7,000 per year. Its current level of sales is
400 units. What will happen to EBIT if sale decreases to 300 units?
a. EBIT will decrease by Rs. 2000
b. EBIT will increase by 2000
c. EBIT will decrease to Rs. 500
d. None

47. A firm has sales of 10,00,000 variable cost of Rs. 7,00,000 and fixed cost of Rs.
2,00,000 and debt of Rs. 5,00,000 @ 10% rate of interest. Define operating leverage.
a. 4 b. 2 c. 3 d.None of these

48. A firm has sales of 10,00,000 variable cost of Rs. 7,00,000 and fixed cost of Rs.
2,00,000 and debt of Rs. 5,00,000 @ 10% rate of interest. Define financial leverage.
a. 3 b. 2 c. 2.5 d. None

49. A firm has sales of 10,00,000 variable cost of Rs. 7,00,000 and fixed cost of Rs.
2,00,000 and debt of Rs. 5,00,000 @ 10% rate of interest. Define Combined leverage.
a. 6 b.6.5 c. 5 d. None

50. A firm has sales of 10,00,000 variable cost of Rs. 7,00,000 and fixed cost of Rs.
2,00,000 and debt of Rs. 5,00,000 @ 10% rate of interest. If firm wants to double
its earnings before interest and tax (EBIT), how much of rise in sales would be
needed on a percentage basis?
a. 33.33 % b. 66.67% c. 20% d. None

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51. Firm has sales of Rs. 50 Lakhs, variable costs of Rs. 35 lakhs, fixed cost of Rs.
7 lakhs, 10% Debt of Rs. 30 Lakhs & equity capital of Rs. 55 Lakhs. Calculate
operating & Financial Leverage.
a. 1.875 & 1.6 b. 1.6 & 1.875 c. 1.875 & 2 d. None

52. Compute the combined leverage from the following data – (a) EBIT = Rs.
10,00,000 (b) Fixed costs =Rs. 20,00,000 and (c) EBT = Rs. 8,00,000.
a. 4.75 b. 3.75 c. 5.55 d. None

53. The following information is available for ABC & Co

EBIT= Rs. 11,20,000
PBT = 3,20,000
Fixed Costs =7,00,000
Calculate % change in EPS if the sales are expected to increase by 5%
a. 28.4375% b. 28% c. 25% d. None

54. X Corporation has estimated that for a new product its break-even point is
2000 units if the item sold for Rs. 14 per unit, the cost accounting department
has currently identified variable cost of Rs. 9 per unit. Calculate the degree of
operating leverage for sales volume of Rs. 2500 units.
a. 6 b. 4 c. 5 d. None

55. Consider the following data for Omega Ltd, EBIT= Rs. 15,750 lakhs, EBT = Rs.
7,000 Lakhs and Fixed operating Costs = Rs. 1,575 Lakhs. Calculate percentage of
change in EPS, if sales increase by 5%.
a. 13.55% b. 12.38% c. 15% d. None

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 Part A - Leverage

56. Arun Ltd sells 2000 Units at Rs. 10 per unit. Its variable costs ratio is 70% and
Fixed costs is Rs. 1000. The company had raised the required funds by issue of 100,
10% debentures at Rs.100 each and 2000 equity shares @ Rs. 10 per share. The
company’s sales are expected to increase by 20%. Assuming a tax rate of 50%, find
out the impact of increase in sales on its EPS.
a. EPS will decrease by Rs. 2
b. EPS will increase by Rs. 0.3
c. EPS will increase by Rs. 1.3
d. None

57. Calculate operating and financial leverage, combined leverage for the firm on the
basis of the following information:
Production = 800 units
Selling prices per unit = Rs. 15
Variable costs per unit = Rs. 10
Fixed costs = Rs. 1,000
Equity Capital = Rs. 5,000
12% Debt = Rs. 5,000
a. 1.33, 1.25 & 1.67 b. 1.67, 1.25 & 1.33 c. 1.67, 1.33 & 1.25 d. None

58. Calculate operating and financial leverage, combined leverage for the firm on the
basis of the following information:
Production = 800 units
Selling prices per unit = Rs. 15
Variable costs per unit = Rs. 10
Fixed costs = Rs. 2,000
Equity Capital = Rs. 7,500
12% Debt = Rs. 2,500

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a. 2, 1.18 & 2.35 b. 1.18, 2 & 2.25 c. 2.35, 1.18 & 2 d. None

59. Calculate operating and financial leverage, combined leverage for the firm on the
basis of the following information:
Production = 800 units
Selling prices per unit = Rs. 15
Variable costs per unit = Rs. 10
Fixed costs = Rs. 3,000
Equity Capital = Rs. 2,500
12% Debt = Rs. 7,500
a. 40, 10 & 4 b. 4, 10 & 40 c. 10, 4 & 40 d. None

60. The share capital of company is Rs. 10,00,000 with shares of face value of Rs. 10.
The company has debt capital of Rs. 6,00,000 at 10% rate of interest. The sales
of firm are 3,00,000 units per annum at a selling price of Rs. 5 per unit and the
variable cost is Rs. 3 per unit. The fixed cost amount to Rs. 2,00,000. The company
pays tax at 35%. If the sales increase by 10%. Calculate degree of operating
leverage at two levels.
a. 1.5 & 1.43 b. 1.43 & 1.5 c. 1.15 & 1.5 d. None

61. The share capital of company is Rs. 10,00,000 with shares of face value of Rs.
10. The company has debt capital of Rs. 6,00,000 at 10% rate of interest. The
sales of firm are 3,00,000 units per annum at a selling price of Rs. 5 per unit
and the variable cost is Rs. 3 per unit. The fixed cost amount to Rs. 2,00,000.
The company pays tax at 35%. If the sales increase by 10%. Calculate degree of
financial leverage at two levels.
a. 1.15 & 1.18 b. 1.18 & 1.15 c. 1.76 & 1.15 d. None

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 Part A - Leverage

62. Consider the following information for omega Ltd.

Rs. In Lakh
EBIT 15,750
EBT 7,000
Fixed Operating Costs 1,575

Required Calculate percentage change in earning per share, if sales increase by 5%

a. 12.38% b. 10.37% c. 11.38% d. None

63. A Firm has total capital of Rs. 12 Lakhs with debt equity ratio of 2:1, its DFL is
1.67 times.
If interest on debt is Rs. 1.2 Lakhs, find out Interest rate on debt
a. 16% b. 15% c. 17% d. None

64. A Firm has total capital of Rs. 12 Lakhs with debt equity ratio of 2:1, its DFL is
1.67 times.
If interest on debt is Rs. 1.2 Lakhs, find out EAT if Tax rate is 40%
a. 1.2 Lakhs b. 2.1 Lakhs c. 1 Lakhs d. None

65. A Firm has total capital of Rs. 12 Lakhs with debt equity ratio of 2:1, its DFL is
1.67 times.
If interest on debt is Rs. 1.2 Lakhs & tax rate is 40%, find out EPS if face value
is Rs. 10
a. 2 b. 3 c. 4 d. None

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66. A Firm has total capital of Rs. 12 Lakhs with debt equity ratio of 2:1, its DFL is
1.67 times.
If interest on debt is Rs. 1.2 Lakhs & tax rate is 40%, calculate ROI.
a. 30% b. 20% c. 10% d. None

67. Calculate the EBT if Net worth= Rs. 25 Lakhs, Debts/Equity= 3:1,
Interest rate = 12% and operating profit = Rs. 20 Lakhs
a. 17.75 Lakhs b. 20 Lakhs c. 21 Lakhs d. None

68. Calculate Financial leverage if Net worth= Rs. 25 Lakhs, Debts/Equity= 3:1,
Interest rate = 12% and operating profit = Rs. 20 Lakhs.
a. 1.40 b. 1.13 c. 2 d. None

69. X Ltd has estimated that for a new product its break-even point is 2000 units if
the item is sold for Rs. 14 per unit, the cost accounting department has currently
identified variable cost of Rs. 9 per unit. Calculate the degree of operating leverage
for sales volume of 2500 units.
a. 5 b. 6 c. 2 d. None

70. X Ltd has estimated that for a new product its break-even point is 2000 units if
the item is sold for Rs. 14 per unit, the cost accounting department has currently
identified variable cost of Rs. 9 per unit. Calculate the degree of operating leverage
for sales volume of 3000 units.
a. 3 b. 2 c. 1 d. None

71. A firm’s total costs are totally variable. Define what is DOL?
a. 1 b. 2 c. 3 d. None

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 Part A - Leverage

72. Identify the correct statement. when firm’s total costs are total variable costs &
debt capital is Rs. 5 lakh @ 10% interest rates.
a. DFL & DCL will be equal.
b. DOL & DCL will be equal.
c. DFL & DOL will be equal.
d. None

73. The balance sheet of alpha Ltd is given below.

Liabilities Amount (Rs.) Assets Amount (Rs.)

Equity Capital (Rs.10 per share) 90,000 Fixed Assets 2,25,000
Retained earnings 30,000 Current Assets 75,000
10% Debt 1,20,000
Current Liability 60,000
Total 3,00,000 Total 3,00,000

The company’s total assets turnover ratio is 3, its fixed operating costs is Rs.
1,50,000 and its variable operating cost ratio is 50%. The income tax rate is 50%.
Calculate different type of Leverages for the company.
a. DOL= 1.50, DFL=1.04 & DCL=1.56
b. DOL= 1.04, DFL=1.5 & DCL=1.56
c. DOL= 1.56, DFL= 1.56 & DCL=1.56
d. None.

74. If Debt is Rs. 120000 @ 10% and Equity share capital of Rs. 90000 (Rs. 10 per
share)
Tax rate is 50%. EPS is Rs. 2. Calculate EBIT.
a. Rs. 48000 b. Rs. 58000 c. Rs. 68000 d. None

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75. The balance sheet of ABC Ltd is given below.

Liabilities Amount (Rs.) Assets Amount (Rs.)

Equity Capital (Rs.10 per share) 60,000 Fixed Assets 1,50,000
Retained earnings 20,000 Current Assets 50,000
10% Debt 80,000
Current Liability 40,000
Total 2,00,000 Total 2,00,000

The company’s total assets turnover ratio is 3, its fixed operating costs is Rs.
1,50,000 and its variable operating cost ratio is 50%. The income tax rate is 50%.
Calculate different type of Leverages for the company.
a. DOL=1.43, DFL =1.03 & DCL=1.43
b. DOL=1.38, DFL=1.03 & DCL=1.43
c. DOL=1.43, DFL=1.43 & DCL=1.38
d. None

76. Calculate the degree of operating leverage for the following firms.

Firm A Firm B Firm C

Output (Units) 60,000 15,000 1,00,000
Fixed Costs(Rs.) 7,000 14,000 1,500
Variable Cost per unit (Rs.) 0.20 1.5 0.02
Interest on borrowed funds (Rs.) 4,000 8,000 -
Selling Price per Unit (Rs.) 0.60 5 0.10

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 Part A - Leverage

a. 1.23, 1.36 & 1.41

b. 1.41, 1.36 & 1.23
c. 1.36, 1.23 & 1.41
d. None.

77. Calculate the degree of financial leverage for the following firms.

Firm A Firm B Firm C

Output (Units) 60,000 15,000 1,00,000
Fixed Costs(Rs.) 7,000 14,000 1,500
Variable Cost per unit (Rs.) 0.20 1.5 0.02
Interest on borrowed funds (Rs.) 4,000 8,000 -
Selling Price per Unit (Rs.) 0.60 5 0.10

a. 0, 1.26 & 1.31

b. 1.31, 1.26 & 0
c. 1.26, 0 & 1.31
d. None

78. Calculate the degree of Combined leverage for the following firms.

Firm A Firm B Firm C

Output (Units) 60,000 15,000 1,00,000
Fixed Costs(Rs.) 7,000 14,000 1,500
Variable Cost per unit (Rs.) 0.20 1.5 0.02
Interest on borrowed funds (Rs.) 4,000 8,000 -
Selling Price per Unit (Rs.) 0.60 5 0.10

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a. 0, 1.72 & 1.85

b. 1.72, 0 & 1.85
c. 1.85, 1.72 & 0
d. None

79. X corporation has estimated that for a new product its break-even point is 2,000
units if the item is sold for Rs. 14 per unit, the cost accounting department
has currently identified variable cost of Rs. 9 per unit. Calculate the degree of
operating leverage for sales volume of 2,500 units and 3000 units.
a. 5 & 3 b. 3 & 5 c. 2 & 1 d. None.

80. A Company has annual sales of Rs. 1 Lakh with 60% contribution margin. The
fixed operating costs are Rs. 30,000 and the interest on long-term debt is Rs.
10,000. Compute the combined leverage.
a. 2 b. 1 c. 3 d. None

81. A Company has annual sales of Rs. 1 Lakh with 60% contribution margin. The
fixed operating costs are Rs. 30,000 and the interest on long-term debt is Rs.
10,000. Find its impact on residual income if sales increase by 5%.
a. Residual income would be increased by 15%.
b. Residual income would be decreased by 15%
c. Residual income would remain constant.
d. None.

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 Part A - Leverage

82. 82. The following details of Alpha Ltd for the year ended 2010 are furnished:
Financial Leverage 2:1
Operating Leverage 3:1
Interest charges per annum – Rs. 20 Lakh
Corporate tax rate - 40%
Variable cost as percentage of sales -60%
Calculate DOL, DFL & DCL.
a. DOL-6, DFL-2 & DCL- 3
b. DCL- 6, DOL-3 & DFL-2
c. DOL-3, DFL-2 & DCL-6
d. None.

83. Particulars A B C
Variable cost as % of Sales 66.666 75 50

Interest Expenses 200 300 1000

DOL 5 6 2
DFL 3 4 2
Tax Rate 35% 35% 35%

Calculate sales value for firm A , B & C.

a. A- 8000, B-9600, C-4500
b. A-4500, C-8000, B-9600
c. C-9600, A-4500, B-8000
d. None

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84. Calculate earnings available to shareholders on the basis of information available

below:
Financial Leverage- 3:1
Interest - Rs. 200
Operating leverage- 4:1
Variable cost as a % of sales -66.67%
Income tax rate – 45%
a. 45 b. 55 c. 65 d. None

85. Calculate value of contribution on the basis of information available below:

Financial Leverage- 4:1
Interest - Rs. 300
Operating leverage- 4:1
Variable cost as a % of sales – 75%
Income tax rate – 45%
a. Rs. 1600 b. Rs. 800 c. Rs. 1200 d. None

86. Calculate degree of operating leverage, degree of financial leverage & degree of
combined leverage on the basis of information available below:
Financial Leverage- 2:1
Interest - Rs. 1,000
Operating leverage- 4:1
Variable cost as a % of sales – 50%
Income tax rate – 45%
a. DOL- 4, DFL-2 & DCL-8
b. DOL-8, DFL-4 & DFL-2
c. DCL-8, DFL-2 & DOL-4
d. None

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87. From the following data calculate sales value and degree of operating leverage
Variable costs – Rs. 56,000
Fixed costs- Rs. 20,000
Interest expenses- Rs. 12,000
Financial Leverage – 5:1
Income tax rate – 30%
a. Sales Value- Rs. 81,000 & DOL -2
b. Sales Value- Rs. 71,000 & DOL -2
c. Sales Value- Rs. 91,000 & DOL -2
d. None

88. From the following data calculate fixed costs and degree of financial leverage
Variable costs – 60% of sales
Interest expenses- Rs. 9,000
Operating Leverage – 4:1
Income tax rate – 30%
Sales – Rs. 1,05,000
a. Fixed Costs- Rs. 21,500 & DFL- 7
b. Fixed Costs- Rs. 10,500 & DFL- 7
c. Fixed Costs- Rs.31,500 & DFL- 7
d. None.

89. Find out operating leverage from the following data:

Sales -Rs. 50000
Variable Costs- Rs. 60% of sales value
Fixed Costs – Rs. 12,000
a. DOL-3 b. DOL-4 c. DOL-1 d. None

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90. Find out the financial leverage from the following data-
Net worth Rs. 25,00,000
Debt/equity ratio- 3:1
Interest rate – 12%
Operating profit – Rs. 20,00,000
a. 1.14 b. 1.13 c. 1.12 d. None

91. A company operates at production level of 5,000 units. The contribution is Rs. 60
per unit, operating leverage is 6, combined leverage is 24, if tax rate is 30%. What
would be its earnings after tax.
a. Rs. 7,750 b. Rs. 8,750 c. Rs. 9,750 d.None

92. If operating leverage is 6, combined leverage is 24, calculate degree of Financial

leverage.
a. 5 b. 2 c. 4 d. None

93. A company operates at production level of 5,000 units. The contribution is Rs. 60
per unit, operating leverage is 6, combined leverage is 24, if tax rate is 30%. What
would be its earnings after tax.
a. Rs. 1750 b. Rs. 1850 c. Rs. 1950 d. None

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