CHAPTER 9:

Leverage
Presented by:
Jhon Paul Montilla
Sheila Joy Bancud
Yna Gatuz
Val Tumaliuan
Ayesa Reyes
Break Even Analysis
 is a financial calculation that weighs the costs of a new
business, service or product against the unit sell price to
determine the point at which you will break even.
 Break-even analysis is a way to find out the minimum sales
volume so that a business does not suffer losses. A break-
even point analysis is a powerful tool for planning and
decision making, and for highlighting critical information
like costs, quantities sold, prices, and so much more.
 Break Even Analysis Formula:
 Break-Even point (units) = Fixed Costs ÷ (Sales price per unit –
Variable costs per unit)
Example:
Beth has dreams of opening a gourmet cupcake store. She does a break-
even analysis to determine how many cupcakes she’ll have to sell to
break even on her investment. She’s done the math, so she knows her
fixed costs for one year are $10,000 and her variable cost per unit is
$.50. She’s done a competitor study and some other calculations and
determined her unit price to be $6.00.

$10,000 / ($6 – $0.50) = 1,819 cupcakes that Beth must sell in one year
to break even
Operating Leverage
A cost-accounting formula that measures the
degree to which a firm or project can increase
operating income by increasing revenue. A
business that generates sales with a high gross
margin and low variable costs has high
operating leverage.
Operating Leverage Formula:
𝑄 ( 𝑃 −𝑉 )
Degree of operating leverage =
𝑄 ( 𝑃 −𝑉 ) − 𝐹

Where:
Q = The number of units
P = The price per unit
V = The variable cost per unit
F = The fixed cost
Example:
The management of ABC Corp. wants to determine the
company’s current degree of operating leverage. The
company sells 10,000 product units at an average price of
$50. The variable cost per unit is $12, while the total fixed
cost are $100,000.

The Company DOL is:

Degree of Operating Leverage = = 1.36
Financial Leverage:
 Financial leverage results from using borrowed capital as a funding
source when investing to expand the firm's asset base and generate
returns on risk capital. Leverage is an investment strategy of using
borrowed money—specifically, the use of various financial instruments
or borrowed capital—to increase the potential return of an investment.
Strategic endeavor of borrowing money to invest in assets. The goal is
to have the return on those assets exceed the cost of borrowing funds
that paid for those assets. The goal of financial leverage is to increase
an investor's profitability without requiring to have them use additional
personal capital.
Financial Leverage Formula:
Financial Leverage=
=

EBIT is referred to as the linking point in the study of leverage.

When calculating the operating leverage, EBIT is a dependent
variable that is determined by the level of sales.
For Example:
XYZ Company has an EBIT of $1,000,000.
The interest liability is $150,000. The company has issued 10% preference shares of
$500,000 and 50,000 equity shares of $100 each. The average tax applicable to the
company is 30% and corporate dividend tax is 20%.
 EPS=
Number of equity shares = 50,000

EPS = Earnings available to equity holders / Number of shares = 535,000 / 50,000

EPS = 10.7

= 1,000,000 / 850,000 - 60,000 ÷ (1 - 0.30)

= 1,000,000 / 850,000 - (60,000 ÷ 0.7)

= 1.000.000 / 850,000 - 85,714

Therefore, the degree of financial leverage = 1,000,000 / 764,286 = 1.308

Total Leverage:
 The degree of total leverage is a ratio that compares the rate of change a
company experiences in earnings per share (EPS) to the rate of change it
experiences in revenue from sales. he degree of total leverage can also be
referred to as the “degree of combined leverage” because it considers the
effects of both operating leverage and financial leverage.
Total Leverage Formula:
Degree of total leverage = Degree of operating leverage x
Degree of financial leverage

Example:
Assume that Company ABC’s current EPS is $3,
and it is trying to determine what its new EPS will
be in the event that it experiences a 10% increase
in sales revenue.
For our example, also assume the following for Company ABC:
Contribution margin is $15 million
Fixed costs are $3 million
Interest expenses are $1.5 million
The first step in determining Company ABC’s new EPS is to calculate the percentage of response that the
current EPS will experience with a 1% change in revenue from sales, which is also equal to the degree of
operating leverage. The calculation should look something like this:

$15m/$15m – $3m (1.25) x $15m – $3m / $15m – $3m – $1.5m (1.14) = 1.25 x 1.14 = 1.43%

The degree of total leverage for Company ABC is 1.43%. The figure can then be used to help the company
determine what its new EPS will be if it sees a 10% increase in sales revenue. The calculation for the new
EPS should look like this:

$3 (current EPS) x (1 + 1.43 x 10%) = $3.49