LEVERAGE

ANALYSIS
(Jindal Steel & Power Ltd)
(SAIL)
 Financial Management Research Paper

Shaurya Singru
17089
BMS 2-B
TABLE OF CONTENTS:

 Introduction
 Objectives
 Research Methodology
 Study Findings
 Conclusion
 INTRODUCTION:

The term ‘leverage’, in general, connotes efficiency and has been

described as the power of lever and the mechanical advantage gained by it.
As mentioned by Van Horne (2003), “Leverage may be defined as the
employment of an asset or funds for which the firm pays a fixed cost or
fixed return. The fixed cost or return may be thought of as the fulcrum of
the lever.”

In a business, there are three types of leverage:

1. OPERATING LEVERAGE:

Operating leverage refers to the percentage of fixed costs that a company

has. Stated another way, operating leverage is the ratio of fixed costs to
variable costs. It measures the impact of changes in sales on earnings.

The higher the operating leverage a business possesses, the more difficult
it is to forecast the earnings of the business. For example, a relatively
small error in forecasting sales can be magnified into large errors in
earnings projections. If sales decrease by 10 percent, then earnings may
decrease by 30 percent. This means that businesses that have high fixed
costs typically report erratic earnings, which makes them more difficult to
 value. In contrast, businesses that have low fixed costs and high variable
costs present lower volatility in earnings and are simpler to value. For
example, a 10 percent growth rate in sales for a variable-cost firm could
translate into 10 percent growth in earnings. The earnings are therefore not
as volatile as a business with high amounts of operating leverage.

Degree of Operating Leverage (DOL): % change in EBIT/ % change in

sales.

2. FINANCIAL LEVERAGE

Financial leverage is the use of debt to acquire additional assets. It is also

known as trading on equity. It refers to the amount of debt in the capital
structure of the business firm.

If you can envision a balance sheet, financial leverage refers to the right-
hand side of the balance sheet. Operating leverage refers to the left-hand
side of the balance sheet - the plant and equipment side. Operating
leverage determines the mix of fixed assets or plant and equipment used
by the business firm. Financial leverage refers to how the firm will pay for
it or how the operation will be financed.

Degree of financial leverage: % change in EPS/% change in EBIT

3. COMBINED LEVERAGE

Combined, or total, leverage is the total amount of risk facing a business

firm, or it is the total amount of leverage that we can use to magnify the
returns from our business.

Operating leverage magnifies the returns from our plant and equipment or
fixed assets. Financial leverage magnifies the returns from our debt
financing. Combined leverage is the total of these two types of leverage or
the total magnification of returns. This is looking at leverage from a
balance sheet perspective.

Degree of Combined Leverage: % change in EPS/% change in Sales

 OBJECTIVES:
 To study the relationship among operating leverage, financial leverage and
combined leverage (total leverage) of the sample firms

 To identify the ideal combination of leverages in firms

RESEARCH METHODOLOGY:
For the purpose of this study, two companies from the Steel Industry were
chosen: Jindal Steel and Power Limited and Steel Authority of India
Limited, a PSU. The financial statements of the two companies were
analysed. The time period selected consisted of the Financial Years 2017-
 18, 2016-17, 2015-16, 2014-15, and 2013-14. The Annual Reports of the
company and Capitaline were used to extract the relevant data.

The data obtained namely the EBIT, PBT, Net Sales and Variable Costs
were further analysed and used to calculate the following Degrees of
Leverage of the two firms:

1. Degree of Financial Leverage

DFL = EBIT/ PBT

2. Degree of Operating Leverage

DOL = Contribution/ EBIT

3. Degree of Combined Leverage

DCL = Contribution/ PBT

Independent sample t-tests were further used to see if there was a

significance difference between the population means i.e. if the degrees of
leverage of the two firms differed greatly.

HYPOTHESIS:
The following hypotheses were set up for the purpose of the study:

1. H0: There is no significant difference between financial leverage of sample

firms.

H1: There is a significant difference between financial leverage of sample

firms.

2. H0: There is no significant difference between operating leverage of

sample firms.
 H1: There is a significant difference between operating leverage of sample
firms.

3. H0: There is no significant difference between combined leverage of

sample firms.

H1: There is a significant difference between combined leverage of sample

firms.

RESULTS:
JINDAL STEEL AND POWER LTD.:
From the above information, the Degree of Leverage were calculated and
the following are the results:

It is evident from this table that Jindal Steel and Power Limited has seen a
lot of variation in the Degrees of leverage in the past few years. While the
Degree of Operating Leverage has increased from 1.2 in 2013-14 to 2.2 in
2017-18, the Degree of Financial Leverage has decreased from 1.2 in
2013-14 to -0.6 in 2017-18.

STEEL AUTHORITY OF INDIA:

From the above information, the Degrees of Leverage were calculated and
the following results were obtained:

This table shows us the trends in the Degrees of Leverage of Steel

Authority of India Limited. As can be seen, while the Degree of Operating
Leverage has not changed much in the years, the Degree of Financial
Leverage has seen a marginal decline from 1.2 in 2013-14 to 0.7 in 2017-
18.
INDEPENDENT SAMPLE T-TEST:

After calculating the Degrees of Leverage, Independent Sample t – tests

were applied to each of the three degrees of leverage to see if the
difference in the degrees for both the companies was significant. SPSS
Software was used to this aim.

Degree of Financial Leverage:

Degree of Operating Leverage:
Degree of Combined Leverage:
 ANALYSIS AND
INTERPRETATION:
1. For specifically Jindal Power and Steel Limited, the degree of
operating leverage have been fairly positive, and on the rise across the
spectrum of 5 years, which can be interpreted as the company is growing
more volatile over the years to percentage change. In generic terms, DOL
refers to proportion change to EBIT to percent change in sales, or in this
case proportion change to contribution of the firm.

2. The degree of financial leverage is positive from 2014 to 2016, but

digresses to a negative number in 2018. This situation is unfavourable for
Jindal Power and Steel Ltd. as it means that the earning per share reduces
by .6% change in EBIT. The said change can possibly be attributed to
higher interest cost for the firm than the return on investment.

3. The degree combined leverage is increasing until 2017 for Jindal

Power and Limited, which can be interpreted as the firm growing riskier as
the EPS grows more volatile and unpredictable to percent change to sales.

4. On similar lines, DOL, DFL and DCL for Steel Authority of India
Ltd. are though positive are pretty stable. They are neither to high nor
negative. Which clearly indicate that the firm grows less risky and less
 volatile across years.

5. The significance level of test independence of means in all three

cases (DOL/DFL/DCL) is less than 5%, hence, there is less than a 5%
chance for the situation assumed in null hypothesis will occur. Hence we
shall reject all null hypothesis.

6. Hence we can say that there is considerable difference in the

operating leverage, financial leverage and combined leverage of Jindal
Steel and Power limited and Steel authority of India.

CONCLUSION:
The difference between degrees of operating leverage in Jindal Power and
Steel and SAIL was significant. Similarly, the difference between degree
of combined leverage of the companies Jindal Power and Steel and SAIL
was significant.

Hence, it can be concluded from this study that there was a significant
difference between actual and estimated degree of leverage of the
companies as well as between the degree of leverage of Jindal Power and
Steel and SAIL.