LEVERAGE | CS Ritika Gupta

Leverage [unit – 3]

1. A firm has sales of Rs.40 lakh, variable cost of Rs.25 lakhs, fixed cost of Rs. 6 lakhs , 10% debentures of
Rs.30 lakhs and equity capital of Rs. 45 lakhs. Calculate operating and financial leverage?
[Ans: OL: 1.67 ; FL: 1.5]

2. Consider the given information for XYZ Ltd

(in lakhs)
Sales (variable cost 70% of sales) 8,000
EBIT 1950
PBT 950
Tax rate 40%
Calculate different types of leverage. Calculate percentage change in EPS if sales increases by 5%.
[Ans: OL: 16/13; FL: 39/19; CL : 48/19 ; %age change in EPS : 12.63%]

3. Consider the following information about X ltd.

EBIT Rs.12,00,000
EBT Rs.3,00,000
Operating Fixed cost Rs.24,00,000
Preference dividend Rs.60,000
Tax rate 40%
Calculate the degree of Operating , financial and combined leverage. By what percentage the operating
profit would increase, if sales increase by 10%?
[Ans: DOL= 3; DFL=6; DCL= 18; % increase in EBIT = 30%]

4. The capital structure of Radhika Ltd. consists of equity share capital of Rs.10,00,000 (The par value of
one equity share is Rs 100) and Rs.10,00,000 of 10% debentures. The unit sales increased by 20% from
1,00,000 units to 1,20,000 units, the selling price is Rs.10 per unit , variable cost amount to Rs.6 per unit
and fixed expenses amount to Rs.2,00,000. The income tax rate is 35%.
You are required to calculate:
i) The percentage of increase in EPS.
ii) The degree of financial leverage at 1,00,000 and 1,20,000 units.
iii) The degree of Operating leverage at 1,00,000 and 1,20,000 units.
Comment on the behavior of operating and financial leverage in relation to increase in production
from 1,00,000 to 1,20,000 units.

[Ans: (i) 80% (ii) OL decreases from 2 to 1.714 (iii) FL decreased from 2 to 1.555] [B.COM (H), 2011]

CS Ritika Gupta, Assistant Professor, Department of Commerce, Satyawati College (Eve.)

Contact: ritikagupta.commerce@satyawatie.du.ac.in 1
 LEVERAGE | CS Ritika Gupta

5. The balance sheet of shaw and Co. is as follows:

Liabilities Rs. Assets Rs.
Equity shares 60,000 Fixed assets 1,50,000
Retained earnings 20,000 Current assets 50,000
10% long – term debt 80,000
Current liabilities 40,000
2,00,000 2,00,000
The company’s total asset turnover ratio is 3, its operating costs are Rs.1,00,000 and its variable
operating costs ratio is 40%. The tax rate is 50%. Calculate the company different types of leverage given
that the face value of share is Rs.10
[Ans: DOL: 1.385; DFL : 1.032; DCL : 1.429] [B.COM(H),2000]

6. The following data are available for ABC Ltd.

Sales 5,00,000
Less : variable cost 2,00,000
Contribution 3,00,000
Less : fixed cost 1,50,000
EBIT 1,50,000
LESS: Interest 25,000
EBT 1,25,000
i) Using the concept of operating leverage by what percentage will EBIT increase if there is 10%
increase in sales.
ii) Using the concept of financial leverage by what percentage will be taxable income increase if EBIT
increase by 6%.
iii) Using the concept of operating leverage by what percentage will taxable income increase if the sales
increase by 8%.
[(i)20% (ii) 7.2% (iii) 19.2%][B.COM (H), 2009]

7. The following details of SR Ltd. for the year ended 31.3.2011 are furnished.
Operating leverage 3:1
Financial leverage 2:1
Interest charges per annum Rs.20 lakhs
Corporate tax rate 50%
Variable cost as percentage of sales 60%
Prepare income statement of the company?
[Ans: EAT: 10 LAKHS] [B.COM(H) , 2013]

CS Ritika Gupta, Assistant Professor, Department of Commerce, Satyawati College (Eve.)

Contact: ritikagupta.commerce@satyawatie.du.ac.in 2
 LEVERAGE | CS Ritika Gupta

8. The karnal Recreational Ltd. manufactures a full line of lawn furniture. The average selling price of a
finished unit is Rs.2500 and variable cost of Rs.1500 per unit. Fixed cost for the company is Rs.50,00,000
per year.
i) What is the Breakeven point in units for the company?
ii) Find the degree of operating leverage at the following production and sales level: 4000 units, 5000
units; 6000 units ; 8000 units.
iii) Does the degree of operating leverage increase or decrease as the production and sales level rises
above the breakeven point? What conclusion would you draw from such increase or decrease?
iv) By what percentage the EBIT will increase if the company’s sales increases by 10% from the
production and sales level of 8000 units?
[Ans: (i) 5000 units (ii) 6000 & 8000 are favourable (iv) 2.67%][B.COM(H), 2010]

9. The data related to two companies are given below:

Company A Company B
Capital 6,00,000 3,50,000
12% Debentures 4,00,000 6,50,000
Output (units) p.a 60,000 15,000
Selling price/ unit Rs.30 Rs250
Fixed cost p.a 7,00,000 14,00,000
Variable cost p.a Rs.10 Rs75
You are required to calculate the operating leverage, financial Leverage and combined leverage of 2
companies.
[Ans: DOL= 2.4,2.14 ; DFL = 1.11;1.07 ; DCL= 2.66,2.29]

10. Prepare income statement and calculate EPS from information given below:
PV Ratio 40%
Operating leverage 1.5000
Financial leverage 1.421
Interest liability Rs.8,000
Tax rate 30%
No of equity shares 10,000
Prepare the income statement and find out EPS.
[Ans: EPS : 1.33 , PAT: 13,300]

11. The capital structure of Greaves Ltd. consist of following:

Equity shares of Rs. 10 each Rs.40,00,000
10% Preference share of Rs.100 each Rs.30,00,000
12% Secured Debenture of Rs.100 each Rs.20,00,000

CS Ritika Gupta, Assistant Professor, Department of Commerce, Satyawati College (Eve.)

Contact: ritikagupta.commerce@satyawatie.du.ac.in 3
 LEVERAGE | CS Ritika Gupta

The net sales for the company were Rs.1.6 crore. EBIT is estimated to be 10% of sales. Corporate tax
rate is 40%. Fixed cost is estimated to be Rs.50,00,000.
i) Draw income statement of greaves ltd.
ii) Calculate the operating and financial leverage.
iii) What will be the % change in EPS if EBIT rises by 10%? What will be new EPS?
[Ans: i) income: Rs.5, 16,000, EPS: 1.29 ii) OL: 4.125 FL: 1.86 iii) 1.53] [B.COM (H), 2017]

12. A company operates at a production level of 1000 units. The contribution is Rs.60 per unit , operating
leverage is 6 and the combined leverage is 24. If tax rate is 30%. What would be its earnings after tax?
[Ans: Rs.1750]

13. Calculate operating and financial leverage under situation A,B, and C and financial plans I,II and III
respectively from the following information relating to the operation and capital structure of XYZ Co.
Also, find out the combinations of operating and financial leverage which gives the highest value and the
least value. How are these calculations useful to finance manager in a company?
Installed capacity 1200 units
Actual production and sales 800 units
Selling price per unit (Rs.) 15
Variable cost per unit (Rs) 10
Fixed cost: Situation A Situation B Situation C
1000 2000 3000
Cost of debt is 12%
Capital structure Financial plan
I (Rs.) II (Rs.) III (Rs.)
Equity 5,000 7,500 2,500
Debt 5,000 2,500 7,500

[Ans: DOL: A - 1.33,B – 2.00, C – 4; DFL : A – 1.25,1.11,1.43 , B – 1.43,1.18, 1.82, C – 2.5, 1.43,10.0}

CS Ritika Gupta, Assistant Professor, Department of Commerce, Satyawati College (Eve.)

Contact: ritikagupta.commerce@satyawatie.du.ac.in 4