Leverages

1 Degree of Operating Leverage The degree of operating leverage is a multiple that measures h

Percentage change in EBIT

Degree of Operating Leverage = =
Percentage change in sales

Change in EBIT
=

DOL

Degree of Operating Leverage at Q(P - V)

=
point Q Units Q(P - V) - F

Degree of Operating Leverage at S - VC

=
point Q Dollars S - VC - F

2 Degree of Financial Leverage The degree of Financial leverage is a multiple that measures h

Percentage change in EPS

Degree of Financial Leverage = =
Percentage change in EBIT

3 Degree of Combined/Total Leverage

=
 =
Degree of Total Leverage = (DOL)*(DFL)

Q(P - V)
= X
Q(P - V) - F

Q(P - V)
= =
EBIT-I
is a multiple that measures how much operating income will change in response to a change in sales.
EBIT
EBIT
Q
Q

[(Q1(P-V)-F)-(Q(P-V)-F)]
Q(P-V)-F

[ Q1P - Q1V - F - QP + QV + F]
Q(P-V)-F

[ Q1P - QP - Q1V + QV ]
Q(P-V)-F

[ P (Q1-Q) - V (Q1-Q)] Q (P-V)

=
Q(P-V)-F Q(P-V)-F

Q (P-V)
Q(P-V)-F Q (P-V) Q
= X
Q Q(P-V)-F Q
Q
Q(P-V)
=
Q(P-V)-F

P Average selling price

V Variable cost per unit Useful to analyse a single product
F Fixed operating cost

S Sales in dollars Useful to analyse a entire firm

is a multiple that measures how much Earning after Interest and tax will change in response to a change in Earnings before interest an

EBIT EBIT
=
EBIT-I EBT

Percentage change in EPS

Percentage change in Sales

EBIT As EBIT = Q (P-V) -F

EBIT-I

Q(P - V) Contribution
=
EBT EBT
 Income Statement

Sales
Less Variable Cost
Contribution
Less Fixed Operating Cost
EBIT
Less Interest
EBT
Less Tax
EAT
Divide by No of equity shares
Contribution EPS
=
se a single product EBIT

se a entire firm

ge in Earnings before interest and Tax.

Operating Leverage

Combined Leverages

Financial leverage
Fast-Mover Midcap Fund follows an investing strategy where it trades stocks based on expected performance i
The fund’s research team has selected two stocks from the hotel industry, Oaktree Hotels and Serenity Hotels.

Comparative Profit and Loss Statements of Two Hotel Companies

Oaktree Hotels
Revenues 200
Food and Beverage expenses 20
Employee benefit Expenses 50
Depreciation and amortisation 25
Other expenses 75

Total Operating Expenses 170

EBIT 30
Interest 15

EBT 15

Tax (25%) 3.75

Profit after tax 11.25

Number of Shares 2.4
Earnings per share 4.69
P/E 19.2
Share Price 90

Note: Assume that variable costs include only food and beverage expenses.

1. Estimate the degree of operating leverage, degree of financial leverage and degree of total leverage for both
2. Assume that the revenues of both the hotels will rise in the next year by five per cent only because of the inc
Changes in average room rates and costs are expected to be negligible. Predict the change in EBIT and EPS of b
3. Predict the change in EBIT and EPS in a pandemic year, if the demand falls by 50%, but tariffs and unit costs r
 expected performance in six to twelve months.
els and Serenity Hotels.

Rs. Crore
Serenity Hotels
46
5
8
7
11

31

15
0

15

3.75

11.25 112500000 112500000

2.8 24000000 28000000
4.02
19.6
78.8

of total leverage for both hotel companies.

t only because of the increase in occupancy rates and no planned addition to capacity.
nge in EBIT and EPS of both the companies.
ut tariffs and unit costs remain relatively stable.
Degree of Operating Leverage

Degree of Operating S - VC
Leverage = =
S - VC - F

Oaktree Hotels Serenity Hotels

Revenues 200 46
Less Food and Beverage expenses 20 5
Contribution 180 41
Less Fixed Cost 150 26
EBIT 30 15

Degree of Operating Leverage

Contribution 180 41
EBIT 30 15

DOL 6 2.73

with 1% change in sales , the EBIT will change by 6 times

with 1% increase in sales , the EBIT will increase by 6 times
with 1% decrease in sales , the EBIT will decrease by 6 times
 Degree of Financial Leverage

Contribution Degree of Financial EBIT

Leverage =
EBIT EBT

Oaktree Hotels
Revenues 200
Less Food and Beverage expenses 20
Contribution 180
Less Fixed Cost 150
EBIT 30
Interest 15
EBT 15
Taxes 3.75
EAT 11.25
No.of Shares 2.4
EPS 4.69

Degree of Financial Leverage

EBIT 30
=
EBT 15

= 2

with 1% change in EBIT , the EPS will change by 2 times

with 1% increase in EBIT , the EPS will increase by 2 times
with 1% decrease in EBIT , the EPS will decrease by 2 times
 Degree of Total Leverage

Degree of Total
Leverage = (DOL)*(DFL) or

Serenity Hotels Oaktree Hotels = 12

46
5
41 =
26
15 Serenity Hotels = 2.73
0
15
3.75 =
11.25
2.8
4.02 with 1% change in SALES , the EPS will change by 2.73 times
with 1% increase in SALES , the EPS will increase by 2.73 times
with 1% decrease in SALES , the EPS will decrease by 2.73 times

15
15

1
 Contribution
EBT

180
15

12

41
15

2.73

PS will change by 2.73 times

EPS will increase by 2.73 times
EPS will decrease by 2.73 times
Degree of Operating Leverage

Degree of Operating S - VC
Leverage = =
S - VC - F

Oaktree Hotels Year 1

Revenues 200 210
Less Food and Beverage expenses 20 21
Contribution 180 189
Less Fixed Cost 150 150
EBIT 30 39

Oaktree Hotels
Degree of Operating Leverage

EBIT 9
EBIT 30
=
Q 10
Q 200

Serenity Hotels

Degree of Operating Leverage

EBIT 2.05
EBIT 15
=
Q 2.3
Q 46
 Contribution Degree of Financial
EBIT Leverage

Serenity Hotels Year 1

46 48.3
5 5.25 Less
41 43.05
26 26 Less
15 17.05

0.3
=
0.05

= 6

0.136666666667
=
0.05

= 2.733
Degree of Financial Leverage

Percentage change in EPS

=
Percentage change in EBIT

Oaktree Hotels Year 1

Revenues 200 210 46
Food and Beverage expenses 20 21 5
Contribution 180 189 41
Fixed Cost 150 150 26
EBIT 30 39 15
Interest 15 15 0
EBT 15 24 15
Taxes 3.75 6 3.75
EAT 11.25 18 11.25
No.of Shares 2.4 2.4 2.8
EPS 4.69 7.50 4.02

Degree of Financial Leverage

Oaktree Hotels

EPS 2.81
EPS 4.69
= =
EBIT 9
EBIT 30

0.6
= =
0.3

= 2 =
 Year 1
48.3
5.25
43.05
26
17.05
0
17.05
4.2625
12.7875
2.8
4.57

Serenity Hotels

0.55
4.02
2.05
15

0.137
0.137