Chapter 1 - Leverages

Chapter 1
Financing Decision - Leverages
Computation of DOL, DFL and DCL
Question 1 - Nov 13
Calculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage
for the following firms:
Particulars N S D
Production (in units) 17,500 6,700 31,800
Fixed cost (₹) 4,00,000 3,50,000 2,50,000
Interest on loan (₹) 1,25,000 75,000 Nil
Selling price per unit (₹) 85 130 37
Variable cost per unit (₹) 38.00 42.50 12.00

Question 2 - Study Material, May 11

You are given two financial plans of a company which has two financial situations. The detailed information is
as under:
Installed Capacity 10,000 units
Actual Production and Sales 60% of installed capacity
Selling Price per unit ₹ 30
Variable cost per unit ₹ 20
Fixed cost Situation A = ₹ 20,000 Situation B = ₹ 25,000

Capital Structure of the company is as follows:

Financial Plans
XY (₹) XM (₹)
Equity 12,000 35,000
Debt (Cost of Debt 12%) 40,000 10,000
52,000 45,000
You are required to calculate operating Leverage and Financial Leverage of both the plans.

Question 3 - Study Material, Nov 02

The data relating to two Companies are as given below:
Particulars Company A Company B
Equity Capital ₹ 6,00,000 ₹ 3,50,000
12% Debentures ₹ 4,00,000 ₹ 6,50,000
Output (units) per annum 60,000 15,000
Selling price/ unit ₹ 30 ₹ 250
Fixed Costs per annum ₹ 7,00,000 ₹ 14,00,000
Variable Cost per unit ₹ 10 ₹ 75
You are required to calculate the Operating leverage, Financial leverage and Combined leverage of two
Companies.

Question 4 - Study Material, May 2019

The capital structure of ABC Ltd. consist of an ordinary share capital of ₹ 5,00,000 (equity shares of ₹ 100
each at par value) and ₹ 5,00,000 (10% debenture of ₹ 100 each). Sales increased from 50,000 units to 60,000
units, the selling price is ₹ 12 per unit, variable cost amounts to ₹ 8 per unit and fixed expenses amount to ₹
1,00,000. The income tax rate is assumed to be 50%.
You are required to calculate the following:
(a) The percentage increase in earnings per share;
(b) The degree of financial leverage at 50,000 units and 60,000 units;
(c) The degree of operating leverage at 50,000 units and 60,000 units;
(d) Comment on the behaviour E.P.S., operating and financial leverage in relation to increases in sales from
50,000 units to 60,000 units.

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Question 5 - Study Material, May 97

A firm has sales of ₹ 75,00,000 variable cost of ₹ 42,00,000 and fixed cost of ₹ 6,00,000. It has a debt of ₹
45,00,000 at 9% and equity of ₹ 55,00,000.
(i) What is the firm’s ROI?
(ii) Does it have favourable financial leverage?
(iii) If the firm belongs to an industry whose asset turNover is 3, does it have a high or low assets leverage?
(iv) What are the operating, financial and combined leverages of the firm?
(v) If the sales drop to ₹ 50,00,000 what will be the new EBIT?
(vi) At what level the EBT of the firm will be equal to zero?

Question 6 - Rtp May 2021

Following information has been extracted from the accounts of newly incorporated Textyl Pvt. Ltd. for the
Financial Year 2020-21:
Sales ₨ 15,00,000
P/V ratio 70%
Operating Leverage 1.4 times
Financial Leverage 1.25 times
Using the concept of leverage, find out and verify in each case:
(i) The percentage change in taxable income if sales increase by 15%.
(ii)The percentage change in EBIT if sales decrease by 10%.
(iii)The percentage change in taxable income if EBIT increase by 15%.

Question 7 - Study Material

X Ltd. details are as under:
Sales (@ 100 per unit) ₹ 24,00,000
Variable Cost 50%
Fixed cost ₹ 10,00,000
It has borrowed ₹ 10,00,000 @ 10% p.a. and its equity share capital share capital is ₹ 10,00,000 (₹ 100 each).
The company is in a tax bracket of 50%. Calculate:
(a) Operating Leverage
(b) Financial Leverage
(c) Combined Leverage
(d) Return on Equity
(e) If the sales increases by ₹ 6,00,000; what will the new EBIT?

Question 8 - May 13, Nov 2016

The following information related to XL company Ltd. For the year ended 31st March, 2013 are available to you:
Equity share capital of ₹ 10 each ₹ 25 lakh
11% Bonds of ₹ 1000 each ₹ 18.5 lakh
Sales ₹ 42 lakh
Fixed cost (Excluding Interest) ₹ 3.48 lakh
Financial leverage 1.39
Profit-Volume Ratio 25.55%
Income Tax Rate Applicable 35%
You are required to calculate:

(i) Operating Leverage;

(ii) Combined Leverage; and
(iii) Earnings Per Share.

Question 9 - Jan 2021

The information related to XYZ Company Ltd. for the year ended 31st March, 2020 are as follows:
Equity Share Capital of ₹ 100 each ₹ 50 Lakhs
12% Bonds of ₹ 1000 each ₹ 30 Lakhs
Sales ₹ 84 Lakhs
Fixed Cost (Excluding Interest) ₹ 7.5 Lakhs
Financial Leverage 1.39
Profit-Volume Ratio 25%

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 Chapter 1 - Leverages

Market Price per Equity Share ₹ 200

Income Tax Rate Applicable 30%
You are required to compute the
following:
(i)Operating Leverage
(ii)Combined Leverage
(iii)Earnings per share
(iv)Earning Yield

Question 10 - Study Material

A Company produces and sells 10,000 shirts. The selling price per shirt is ₹ 500. Variable cost is ₹ 200 per
shirt and fixed operating cost is ₹ 25,00,000.
(a) Calculate operating leverage.
(b) If sales are up by 10%, then what is the impact on EBIT?

Question 11 -
The following summarises the percentage change in E.P.S. percentage change in revenues & betas for four
companies in mobile business
Name of Companies Change in Revenues Change in EPS Beta
Nokia 10% 50% 1.40
Motorola 20% 80% 1.27
Samsung 25% 75% 1.18
Blackberry 30% 75% 1.10
(a) Calculate the Degree of Combined Leverage for each of these companies.
(b) If the Degree of operating leverage of these four companies is 2.5, 2, 2.25 & 1.2 respectively for Nokia,
Motorola, Samsung and Blackberry. Compute Degree of financial Leverage.
(c) Explain why these companies have different betas.

Question 12 - May 2017

You are given the following information of 5 firms of the same industry:
Name of the firm Change in revenue Change in operating Change in Earning
income per share
M 28% 26% 32%
N 27% 34% 26%
P 25% 38% 23%
Q 23% 43% 27%
R 25% 40% 28%
You are required to calculate:
(i) Degree of operating leverage and
(ii) Degree of combined leverage for all firms.

Question 13 - Study Material

PL Forgings Ltd. has the following balance sheet and income statement information:
Balance Sheet as on March 31st
Liabilities ₹ Assets ₹
Equity Capital (₹ 10 per share) 8,00,000 Net Fixed Assets 10,00,000
10% Debt 6,00,000 Current Assets 9,00,000
Retained Earnings 3,50,000
Current Liabilities 1,50,000
19,00,000 19,00,000
Income Statement for the year ending March 31
Particulars ₹
Sales 3,40,000
Operating expenses (including ₹ 60,000 depreciation) (1,20,000)
EBIT 2,20,000
Less: Interest (60,000)
Earnings before tax 1,60,000

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 Chapter 1 - Leverages

Less: Taxes (56,000)

Net Earnings (EAT) 1,04,000
(a) Determine the degree of operating, financial and combined leverages at the current sales level, if all
operating expenses, other than depreciation, are variable costs.
(b) If total assets remain at the same level, but sales (i) increase by 20 percent and (ii) decrease by 20 per
cent, what will be the earnings per share at the new sales level?

Reverse Working with DCL

Question 14 - Nov 08, May 09
A company operates at a production level of 1,000 units. The contribution is ₹ 60 per unit, operating leverage is
6, and combined leverage is 24. If tax rate is 30%, what would be its earnings after tax?

Reverse Working with DFL - ROE and ROI with Interest Rate and Leverage.
Question 15 - May 07
ABC Limited has an average cost of debt at 10 percent and tax rate is 40 per cent. The financial leverage ratio
for the company is 0.60. Calculate Return on Equity (ROE) if its Return on Investment (ROI) is 20%.

Reverse Working with DCL- ROE and ROI

Question 16 - Study Material
The net sales of Carlton Limited is ₹ 30 crores. Earnings before interest and tax of the company as a
percentage of net sales are 12%. The capital employed comprises ₹ 10 crores of equity, ₹ 2 crores of 13%
Cumulative Preference Share Capital and 15% Debentures of ₹ 6 crores. Income-tax rate is 40%.
(i) Calculate the Return-on-equity for the company and indicate its segments due to the presence of
Preference Share Capital and Borrowing (Debentures).
(ii) Calculate the Operating Leverage of the Company given that combined leverage is 3.

Reverse Working with All Leverages

Question 17 - May 07, Nov 2017
The following details of RST Limited for the year ended 31st March, 2006 are given below:
Operating leverage 1.4 times
Combined leverage 2.8 times
Fixed cost (Excluding interest) ₹ 2.04 lakhs
Sales ₹ 30.00 lakhs
12% Debentures of ₹ 100 each ₹ 21.25 lakhs
Equity Share Capital of ₹ 10 each ₹ 17.00 lakhs
Income tax rate 30 per cent
Required:
(i) Calculate Financial leverage.
(ii) Calculate P/V ratio and Earning per Share (EPS).
(iii) If the company belongs to an industry, whose assets turNover is 1.5, does it have a high or low
assets leverage?
(iv) At what level of sales the Earning before Tax (EBT) of the company will be equal to zero?

Question 18 -
Ram Ltd. produces Mobile phones with a selling price per unit of ₹ 100. Fixed cost amount to ₹ 2,00,000. 5,000
units are produced and sold each year. Annual profits amount to ₹ 50,000. The company’s all equity-financed
assets are ₹ 5,00,000.
The company proposes to change its production process, adding ₹ 4,00,000 to investment and ₹ 50,000 to
fixed operational costs. The consequences of such a proposal are:
(i) Reduction in variable cost per unit by ₹ 10
(ii) Increase in output by 2,000 units
(iii) Reduction in selling price per unit to ₹ 95
Assuming a rate of interest on debt is 10%, examine the above proposal and advice whether or not the
company should make the change. Ignore taxation. Also measure the degree of operating leverage and overall
break-even-point.

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Question 19 - Jan 2021

The data of SM Limited for the year ended 31st March 2020 is given below:
Fixed Cost (Excluding Interest) ₹ 2.25 Lakhs
Sales ₹ 45 Lakhs
Equity Share Capital of ₹ 10 each ₹ 38.50 Lakhs
12% Debentures of ₹ 500 each ₹ 20 Lakhs
Operating Leverage 1.2
Combined Leverage 4.8
Income tax rate 30%
Required:
(i)Calculate P/V ratio, Earning per share Financial leverage and Assets turNover.
(ii)If asset turNover of an industry is 1.1, then comment on adequacy of assets
turNover of SM Limited.
(iii)At what level of sales the Earnings before tax (EBT) of SM Limited will be
equal to zero?

Question 20 - May 2018

The following information is related to YZ Company Ltd. for the year ended 31st March, 2020:
Equity share capital (of ₹ 10 each) ₹ 50 lakhs
12% Bonds of ₹ 1,000 each ₹ 37 lakhs
Sales ₹ 84 lakhs
Fixed cost (excluding interest) ₹ 6.96 lakhs
Financial leverage 1.49
Profit-volume Ratio 27.55%
Income Tax Applicable 40%
You are required to CALCULATE:
(i)Operating Leverage;
(ii)Combined leverage; and
(iii)Earnings per share.
Show calculations up-to two decimal points.

Question 21 - Nov 2019 Similar

A company had the following Balance Sheet as on March 31, 2006:
Liabilities and Equity ₹ (In Crores) Assets ₹ (In Crores)
Equity Share Capital (1 10 Fixed Assets (Net) 25
crore shares of ₹ 10 each)
Reserves and Surplus 2 Current Assets 15
20
15% Debentures 20

Current Liabilities 8
40 40

The additional information given is as under:

Fixed Costs per annum (excluding interest) ₹ 8 crores
Variable operating costs ratio 65%
Total Assets turNover ratio 2.5
Income-tax rate 40%
Required: Calculate the following and comment:
(i) Earnings per share (iii) Financial Leverage (v) Current Ratio
(ii) Operating Leverage (iv) Combined Leverage

Question 22 - Mock Oct 2022

Axar Ltd. has a Sales of ₹ 68,00,000 with a Variable cost Ratio of 60%.
The company has fixed cost of ₹16,32,000. The capital of the company comprises of 12% long term debt,
₹1,00,000 Preference Shares of ₹ 10 each carrying dividend rate of 10% and 1,50,000 equity shares.
The tax rate applicable for the company is 30%.

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 Chapter 1 - Leverages

At current sales level, Determine the Interest, EPS and amount of debt for the firm if a 25% decline in Sales will
wipe out all the EPS.

Question 23 - Dec 2021

Information of A Ltd. is given below:
· Earnings after tax: 5% on sales
· Income tax rate: 50%
· Degree of Operating Leverage: 4 times
· 10% debentures in capital structure: ₹ 3 lakhs
· Variable costs: ₹ 6 lakhs
Required:
(i) From the given data complete the following statement:
Sales XXXX
Less: Variable Costs ₹ 6,00,000
Contribution XXXX
Less: Fixed Cost XXXX
EBIT XXXX
Less: Interest Expenses XXXX
EBT XXXX
Less: Income tax XXXX
EAT XXXX
(ii) Calculate the Financial Leverage and Combined Leverage.
(iii)Calculate the percentage change in earning per share, if sales increased by 5%.

Question 24 - May 2022

Details of a company for the year ended 31st March, 2022 are given below:
Sales ₹ 86 lakhs
Profit Volume (P/V) Ratio 35%
Fixed Cost excluding interest expenses ₹ 10 lakhs
10% Debt ₹ 55 lakhs
Equity Share Capital of ₹ 10 each ₹ 75 lakhs
Income Tax Rate 40%
Required:
1. Determine company's Return on Capital Employed (Pre-tax) and EPS.
2. Does the company have a favourable financial leverage?
3. Calculate operating and combined leverages of the company.
4. Calculate percentage change in EBIT, if sales increases by 10%.
5. At what level of sales, the Earning before Tax (EBT) of the company will be equal to zero?

Question 25 - Nov 2022

The following information is available for SS Ltd.
Profit volume (PV) ratio 30%
Operating leverage 2.00
Financial leverage 1.50
Loan ₹ 1,25,000
Post-tax interest rate 5.6%
Tax rate 30%
Market Price per share (MPS) ₹ 140
Price Earnings Ratio (PER) 10
You are required to:
1. Prepare the Profit-Loss statement of SS Ltd. and
2. Find out the number of equity shares.

Question 26 - Rtp May 2022

Company P and Q are having same earnings before tax. However, the margin of safety of Company P is 0.20
and, for Company Q, is 1.25 times than that of Company P. The interest expense of Company P is ₹ 1,50,000

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 Chapter 1 - Leverages

and, for Company Q, is 1/3rd less than that of Company P. Further, the financial leverage of Company P is 4
and, for Company Q, is 75% of Company P.
Other information is given as below:
Particulars Company P Company Q
Profit volume ratio 25% 33.33%
Tax rate 45% 45%
You are required to PREPARE Income Statement for both the companies.

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