{"id":16579,"date":"2023-03-16T11:47:51","date_gmt":"2023-03-16T06:17:51","guid":{"rendered":"https:\/\/gstguntur.com\/?p=16579"},"modified":"2023-03-16T17:17:24","modified_gmt":"2023-03-16T11:47:24","slug":"financing-decisions-leverages-ca-inter-fm-study-material","status":"publish","type":"post","link":"https:\/\/gstguntur.com\/financing-decisions-leverages-ca-inter-fm-study-material\/","title":{"rendered":"Financing Decisions-Leverages \u2013 CA Inter FM Study Material"},"content":{"rendered":"

Financing Decisions-Leverages \u2013 CA Inter FM Study Material<\/a> is designed strictly as per the latest syllabus and exam pattern.<\/p>\n

Financing Decisions-Leverages \u2013 CA Inter FM Study Material<\/h2>\n

Theory Questions<\/strong><\/p>\n

Question 1.
\nDistinguish between business risk and financial risk or \u201cOperating risk is associated with cost structure, whereas financial risk is associated with capital structure of a business concern.” Critically examine this statement. (4 Marks Nov. 2012, May 2013, Nov. 2014)
\nAnswer:
\nBusiness Risk: Business risk refers to the risk associated with the firm\u2019s operations. It is an unavoidable risk because of the environment in which the firm has to operate. The business risk is represented by the change in earnings before interest and tax (EBIT).The change in turn is influenced by revenues and expenses. Revenues and expenses are affected by demand of firm\u2019s products, changes in prices and proportion of fixed cost in total cost.<\/p>\n

Financial Risk: Financial risk refers to the additional risk associated with use of debt or preference share capital. If company raise higher amount from Debt or\/and Preference share capital then such company have higher financial risk than companies financed through equity. Financial risk is measured through financial leverage, total debt to assets ratio etc.<\/p>\n

Practical Problems<\/strong><\/p>\n

Question 1.
\nYou are the given two financial plans of a company which has two financial situations. The detailed information are as under:
\nInstalled capacity : 10,000 units
\nActual production and sales : 60% of installed capacity
\nSelling price per unit : \u20b9 30
\nVariable cost per unit : \u20b9 20
\nFixed Cost:
\nSituation A : \u20b9 20,000
\nSituation B : \u20b9 25,000<\/p>\n

Capital structure of the company is as follows:<\/p>\n

\"Financing<\/p>\n

You are required to calculate operating leverage and financial leverage of both the plans. (4 Marks May 2011)
\nAnswer:
\nStatement Showing Operating & Financial leverage
\n\"Financing<\/p>\n

\"Financing<\/p>\n

Question 2.
\nAlpha Ltd. has furnished the following Balance Sheet as on March 31, 2011:
\n\"Financing<\/p>\n

Additional information:<\/p>\n

    \n
  1. Annual Fixed Cost other than Interest : \u20b9 28,00,000<\/li>\n
  2. Variable Cost Ratio : 60% of sales<\/li>\n
  3. Total Assets Turnover Ratio : 2.5 times<\/li>\n
  4. Tax Rate : 30%<\/li>\n<\/ol>\n

    You are required to calculate:<\/p>\n

    (i) Earning per Share (EPS), and
    \n(ii) Combined Leverage.<\/p>\n

    Answer:<\/p>\n

    (i) Combined leverage = Contribution \u00f7 EBT = 48 lacs \u00f7 15.80 lacs
    \n= 3.04<\/p>\n

    (ii) Calculation of EPS:
    \n\"Financing<\/p>\n

    Question 3.
    \nThe capital structure of JCPL Ltd. is as follows:
    \nEquity share capital of \u20b9 10 each : \u20b9 8,00,000
    \n8% Preference share capital of \u20b9 10 each : \u20b9 6,25,000
    \n10% Debenture of \u20b9 100 each : \u20b9 4,00,000<\/p>\n

    Additional Information:<\/p>\n

    Profit after tax (tax rate 30%) : \u20b9 1,82,000
    \nOperating expenses (including depreciation \u20b9 90,000) : 1.50 times of EBIT
    \nEquity share dividend paid : 15%
    \nMarket price per equity share : \u20b9 20.00<\/p>\n

    Required to calculate:<\/p>\n

    (i) Operating and financial leverage.
    \n(ii) Cover the preference and equity share dividends.
    \n(iii) The earning yield and price earning ratio. (8 Marks May 2012)<\/p>\n

    Answer:<\/p>\n

    (i) Operating & Financial leverage:
    \n\"Financing<\/p>\n

    (ii) calculation of cover the preference & equity share dividends:
    \n\"Financing<\/p>\n

    (iii) Earning yield & price earning ratio.
    \nEarning Yield Ratio \\(=\\frac{\\text { EPS }}{\\text { MPS }}\\) \u00d7 100 = \\(\\frac{1.65}{20.00}\\) \u00d7 100 = 8.25
    \n\"Financing<\/p>\n

    (iv) Net fund flow:
    \nNet fund flow = PAT – Preference dividends – Equity dividends + Depreciation
    \n= 1,82,000 – 50,000 – 1,20,000 + 90,000 = \u20b9 1,02,000<\/p>\n

    Calculation of contribution:
    \n\"Financing<\/p>\n

    Question 4.
    \nX Limited has estimated that for a new product its break-even point is 20,000 units if the item is sold for \u20b9 14 per unit and variable cost \u20b9 9 per unit. Calculate the degree of operating leverage for sales volume 25,000 units and 30,000 units. (5 Marks Nov. 2012)
    \nAnswer:
    \nStatement of Operating Leverage
    \n\"Financing
    \nCalculation of operating fixed cost:
    \nContribution at BEP = Fixed Cost
    \n\u20b9 5 \u00d7 20,000 Units = \u20b9 1,00,000<\/p>\n

    \"Financing<\/p>\n

    Question 5.
    \nThe following information related to XL company Ltd. for the year ended 31st March, 2013 are available to you:
    \nEquity share capital of \u20b9 10 each : \u20b9 25,00,000
    \n11 % Bonds of \u20b9 1,000 each : \u20b9 18,50,000
    \nSales : \u20b9 42,00,000
    \nFixed cost (Excluding Interest) : \u20b9 3,48,000
    \nFinancial leverage : 1.39
    \nProfit Volume Ratio : 25.55%
    \nIncome Tax Rate : 35%<\/p>\n

    You are required to calculate:<\/p>\n

    (i) Operating Leverage;
    \n(ii) Combined Leverage; and
    \n(iii) Earning Per Share. (6 Marks May 2013)<\/p>\n

    Answer:<\/p>\n

    (i) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = \\(\\frac{10,73,100}{7,25,100}\\) = 1.48 times<\/p>\n

    (ii) Combined Leverage = OL \u00d7 FL = 1.48 \u00d7 1.39 = 2.06 times<\/p>\n

    (iii)
    \n\"Financing<\/p>\n

    Working Notes:<\/strong><\/p>\n

    (1) Contribution = Sales \u00d7 PV Ratio
    \n= 42 Lacs \u00d7 25.55% = 10,73,100<\/p>\n

    (2) EBIT = Contribution – Operating Fixed Cost
    \n= 10,73,100 – 3,48,000 = 7,25,100<\/p>\n

    (3) Profit after tax = (EBIT- Interest) (1 – t)
    \n= (7,25,100- 11% of 18,50,000) (1 – 0.35)
    \n= 3,39,040<\/p>\n

    Question 6.
    \nCalculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage for the following firms:
    \n\"Financing
    \n(5 Marks Nov. 13)
    \nAnswer:
    \nStatment of the Degree of OL, Degree of FL and the Degree of CL
    \n\"Financing<\/p>\n

    Question 7.
    \nA company had the following Balance Sheet as on 31st March, 2014:
    \n\"Financing
    \nThe additional information given is as under:
    \nFixed cost per annum (excluding interest) : 4 crores
    \nVariable operating cost ratio : 65%
    \nTotal assets turnover ratio : 2.5
    \nIncome Tax rate : 30%<\/p>\n

    Required:<\/p>\n

    (i) Earnings Per Share
    \n(ii) Operating Leverage
    \n(iii) Financial Leverage
    \n(iv) Combined Leverage<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of EPS:
    \nEPS \\(=\\frac{\\text { EAT }}{\\text { No. of Shares }}\\) \\(=\\frac{840 \\text { Lakhs }}{50 \\text { Lakhs }}\\) = \u20b9 16.80<\/p>\n

    (ii) Calculation of OL:
    \nOL \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) \\(=\\frac{17.50 \\text { Crores }}{13.50 \\text { Crores }}\\) = 1.296 times<\/p>\n

    (iii) Calculation of FL:
    \nFT \\(=\\frac{\\text { EBIT }}{\\text { EBT }}\\) \\(=\\frac{13.50 \\text { Crores }}{12.00 \\text { Crores }}\\) = 1.125 times<\/p>\n

    (iv) Calculation of CL:
    \nCL = OL \u00d7 FL = 1.296 \u00d7 1.125 = 1.458 times<\/p>\n

    Working Notes:<\/strong><\/p>\n

    Income Statement
    \n\"Financing<\/p>\n

    Question 8.
    \nThe capital structure of RST Ltd. is as follows:<\/p>\n

    Equity share capital of \u20b9 10 each : \u20b9 8,00,000
    \n10% Preference share capital of \u20b9 100 each : \u20b9 5,00,000
    \n12% Debenture of \u20b9 100 each : \u20b9 7,00,000<\/p>\n

    Additional Information:<\/p>\n

    Profit after tax (tax rate 30%) : \u20b9 2,80,000
    \nOperating expenses (including depreciation \u20b9 96,800)
    \nEquity share dividend paid : 15%
    \nMarket price per equity share : \u20b9 23.00<\/p>\n

    Required to calculate:<\/p>\n

    (i) Operating and financial leverage.
    \n(ii) Cover the preference and equity share dividends.
    \n(iii) The earning yield and price earning ratio.
    \n(iv) The net fund flow.<\/p>\n

    Note: All operating expenses (excluding depreciation) are variable. (8 Marks Nov. 2014)<\/p>\n

    Answer:<\/p>\n

    (i) Operating & Financial leverage:
    \n\"Financing<\/p>\n

    (ii) Calculation of cover the preference & equity share dividends:
    \n\"Financing<\/p>\n

    (iii) Earning yield & price earning ratio:
    \n\"Financing<\/p>\n

    (iv) Net fund flow:
    \nNet fund flow = PAT – Preference dividends – Equity dividends + Depreciation
    \n= 2,80,000 – 50,000 – 1,20,000 + 96,800
    \n= \u20b9 2,06,800<\/p>\n

    Calculation of contribution
    \n\"Financing<\/p>\n

    \"Financing<\/p>\n

    Question 9.
    \nFollowing information are related to four firms of the same industry:
    \n\"Financing<\/p>\n

    Find out:<\/p>\n

    (i) Degree of operating leverage, and
    \n(ii) Degree of combined leverage of all the firms. (5 Marks May 2015)<\/p>\n

    Answer:<\/p>\n

    (i)
    \n\"Financing<\/p>\n

    (ii)
    \n\"Financing<\/p>\n

    Question 10.
    \nThe capital structure of the ABC Ltd. as at 51.03.15 consists of ordinary share capital of \u20b9 5,00,000 (face value \u20b9 100 each) and 10% debentures of \u20b9 5,00,000 (\u20b9 100 each). In the year ended March 15, sales decreased from 60,000 units to 50,000 units. During the year and in the previous year, the selling price is \u20b9 12 per unit; variable cost stood at \u20b9 8 per unit and fixed expenses were at \u20b9 1,00,000 p.a. The income tax rate was 30%.<\/p>\n

    You are required to calculate the following:<\/p>\n

    (i) The percentage decrease in earnings per share.
    \n(ii) The degree of operating leverage at 60,000 units and 50,000 units.
    \n(iii) The degree of financial leverage at 60,000 units and 50,000 units. (5 Marks June 2015)<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of % decrease in EPS
    \n\"Financing
    \n% Decrease in EPS = \\(\\frac{12.60-7.00}{12.60}\\) \u00d7 100 = 44.44%<\/p>\n

    (ii) Degree of Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \nAt 60,000 units = \\(\\frac{2,40,000}{1,40,000}\\) = 1.71 times
    \nAt 50,000 units = \\(\\frac{2,00,000}{1,00,000}\\) = 2 times<\/p>\n

    (iii) Degree of Financial Leverage \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\)
    \nAt 60,000 units = \\(\\frac{1,40,000}{90,000}\\) = 1.56 times
    \nAt 50,000 units = \\(\\frac{1,00,000}{50,000}\\) = 2 times<\/p>\n

    Question 11.
    \nFrom the following details of X Ltd., prepare the Income Statement for the year ended 31st December 2014:
    \nFinancial Leverage : 2
    \nInterest : \u20b9 2,000
    \nOperating Leverage : 3
    \nVariable cost as a % of sales : 75%
    \nIncome tax rate : 30%
    \n(5 Marks Nov. 2015)<\/p>\n

    Answer:<\/p>\n

    Income Statement for the year ended 31st December, 2014
    \n\"Financing<\/p>\n

    Working Notes:<\/p>\n

    (a) Calculation of EBIT:
    \n\"Financing<\/p>\n

    (b) Calculation of Contribution:
    \n\"Financing<\/p>\n

    (c) Calculation of Sales
    \n\"Financing<\/p>\n

    Question 12.
    \nA company had the following Balance Sheet as on 31st March, 2015.
    \n\"Financing
    \nThe additional information given is as under:
    \nFixed cost per annum (excluding interest) : \u20b9 32,00,000
    \nVariable operating cost ratio : 70%
    \nTotal assets turnover ratio : 2.5
    \nIncome Tax rate : 30%<\/p>\n

    Required:<\/p>\n

    (i) Operating Leverage,
    \n(ii) Financial Leverage,
    \n(iii) Combined Leverage and
    \n(iv) Earnings Per Share (5 Marks May 2016)<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of OL:
    \nOL \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = \\(\\frac{1,20,00,000}{88,00,000}\\) = 1.364 times<\/p>\n

    (ii) Calculation of FL:
    \nFL \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\) = \\(\\frac{88,00,000}{76,00,000}\\) = 1.158 times<\/p>\n

    (iii) Calculation of CL:
    \nCL = OL \u00d7 FL = 1.364 \u00d7 1.158 = 1.579 times<\/p>\n

    (iv) Calculation of EPS
    \nEPS \\(=\\frac{\\text { EAT }}{\\text { No. of Shares }}\\) = \\(\\frac{53,20,000}{4,00,000}\\) = \u20b9 13.30<\/p>\n

    Working Notes:<\/strong><\/p>\n

    Income Statement
    \n\"Financing<\/p>\n

    \"Financing<\/p>\n

    Question 13.
    \nThe following information related to YZ company Ltd. for the year ended 31st March, 2016 are available to you:<\/p>\n

    Equity share capital of \u20b9 10 each : \u20b9 50,00,000
    \n12% Bonds of \u20b9 1,000 each : \u20b9 37,00,000
    \nSales : \u20b9 84,00,000
    \nFixed cost (Excluding Interest) : \u20b9 6,96,000
    \nFinancial leverage : 27.55%
    \nProfit Volume Ratio : 40%
    \nIncome Tax Rate :<\/p>\n

    You are required to calculate:<\/p>\n

    (a) Operating Leverage;
    \n(b) Combined Leverage; and
    \n(c) Earning Per Share [upto two decimal points] (5 Marks Nov. 2016)<\/p>\n

    Answer:<\/p>\n

    (a) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = \\(\\frac{23,14,200}{16,18,200}\\) = 1.43 times
    \n(b) Combined Leverage = OL \u00d7 FL = 1.43 \u00d7 1.49 = 2.13 times
    \n(c)
    \n\"Financing<\/p>\n

    Working Notes:<\/strong><\/p>\n

    1. Contribution = Sales \u00d7 PV Ratio = 84 Lacs \u00d7 27.55%
    \n= 23,14,200
    \n2. EBIT = Contribution – Operating Fixed Cost
    \n= 23,14,200 – 6,96,000 = 16,18,200
    \n3. Profit after tax = (EBIT – Interest) (1 – t)
    \n= (16,18,200 – 12% of 37,00,000) (1 – 0.40)
    \n= 7,04,520<\/p>\n

    Author Note: Calculation of interest through financial leverage will provide different interest, therefore this question alternatively can be solved by taking interest on the basis of following calculation:<\/p>\n

    Financial Leverage = EBIT \u00f7 EBT = 16,18,2004 \u00f7 EBT = 1.49
    \nEBT = 16,18,200 \u00f7 1.49 = 10,86,040
    \nInterest = EBIT – EBT = 16,18,200 – 10,86,040
    \n= 5,32,160<\/p>\n

    Question 14.
    \nYou are given the following information of 5 firms of the same industry:<\/p>\n\n\n\n\n\n\n\n\n
    Firm<\/td>\nChange in Revenue<\/td>\nChange in Operating Income<\/td>\nChange in EPS<\/td>\n<\/tr>\n
    M<\/td>\n28%<\/td>\n26%<\/td>\n32%<\/td>\n<\/tr>\n
    N<\/td>\n27%<\/td>\n34%<\/td>\n26%<\/td>\n<\/tr>\n
    P<\/td>\n25%<\/td>\n38%<\/td>\n23%<\/td>\n<\/tr>\n
    Q<\/td>\n23%<\/td>\n43%<\/td>\n27%<\/td>\n<\/tr>\n
    R<\/td>\n25%<\/td>\n40%<\/td>\n28%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Find out:<\/p>\n

    (a) Degree of operating leverage, and
    \n(b) Degree of combined leverage of all the firms. (5 Marks May 2017)<\/p>\n

    Answer:<\/p>\n

    (a) Degree of Leverage \\(=\\frac{\\% \\text { Change in operating income }}{\\% \\text { Change in revenue }}\\)
    \nM = 26% \u00f7 28% = 0.93
    \nN = 34% \u00f7 27% = 1.26
    \nP = 38% \u00f7 25% = 1.52
    \nQ = 43% \u00f7 23% = 1.87
    \nR = 40% \u00f7 25% = 1.60<\/p>\n

    (b) Degree of Combined Leverage \\(=\\frac{\\% \\text { Change in EPS }}{\\%_0 \\text { Change in revenue }}\\)
    \nM = 32% \u00f7 28% = 1.14
    \nN = 26% \u00f7 27% = 0.96
    \nP = 23% \u00f7 25% = 0.92
    \nQ = 27% \u00f7 23% = 1.17
    \nR = 28% \u00f7 25% = 1.12<\/p>\n

    \"Financing<\/p>\n

    Question 15.
    \nThe following details of a company for the year ended 31 March, 2017 are given below:<\/p>\n

    Operating leverage : 2 times
    \nCombined leverage : 2.5 times
    \nFixed Cost (Excluding interest) : \u20b9 3.04 lakhs
    \nSales : \u20b9 50.00 lakhs
    \n8% Debentures of \u20b9 100 each : \u20b9 30.25 lakhs
    \nEquity Share Capital of \u20b9 10 each \u20b9 34.00 lakhs
    \nIncome tax rate 30 per cent<\/p>\n

    Required:<\/p>\n

    (i) Calculate Financial Leverage.
    \n(ii) Calculate P\/V ratio and Earning Per Share (EPS).
    \n(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a high or low assets turnover?
    \n(iv) At what level of sales the Earning before Tax (EBT) of the company will be equal to zero? (8 Marks Nov. 2017)<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of Financial Leverage:
    \nFinancial Leverage = CL \u00f7 OL = 2.50 \u00f7 2 = 1.25<\/p>\n

    (ii) P\/V Ratio and EPS:
    \n\"Financing<\/p>\n

    Calculation of contribution<\/p>\n

    Operating leverage \\(=\\frac{\\text { Contribution }}{\\text { Contribution }-\\mathrm{FC}}\\) \\(=\\frac{\\text { Contribution }}{\\text { Contribution }-3,04,000}\\) = 2 times
    \n2 Contribution – 6,08,000 = Contribution = 6,08,000<\/p>\n

    Calculation of PAT:
    \nProfit after tax = (Contribution – fixed cost – interest) (1 – t)
    \n= (6,08,000 – 3,04,000 – 8% of 30,25,000)(1 – 0.30)
    \n= 43,400<\/p>\n

    Author Note: Calculation of interest through financial leverage will provide different interest, therefore this question alternatively can be solved by taking interest on the basis of following calculation:<\/p>\n

    Financial Leverage EBIT \u00f7 EBT = 6,08,000 – 3,04,000 \u00f7 EBT
    \n= 1.25 = 3,04,000 \u00f7 EBT
    \nEBT = 3,04,000 \u00f7 1.25 = 2,43,200
    \nInterest = EBT – EBT = 3,04,000 – 2,43,200
    \n= 60,800<\/p>\n

    (iii) Assets turnover:
    \nAssets turnover \\(=\\frac{\\text { Sales }}{\\text { Total Assets }}\\) = \\(\\frac{50,00,000}{64,25,000}\\) = .778
    \n0.778 < 1.5 means lower than industry assets turnover.<\/p>\n

    (iv) Level of saks ro earn zero EBT:
    \nEBT = Sales – Variable cost – Fixed cost – Interest
    \nNil = Sales – 87.84% sales – 3,04,000 – 2,42,000
    \n12.16% of sales = 5,46,000
    \nSales = 44,90,132<\/p>\n

    Question 16.
    \nFollowing are the selected financial information of A Ltd. and B Ltd. for the year ended March 31, 2018:
    \n\"Financing<\/p>\n

    You are required to find out:<\/p>\n

    (1) EBIT
    \n(2) Sales
    \n(3) Fixed cost
    \n(4) Identify the company which is better placed with reasons based on leverages. (5 Marks May 2018)<\/p>\n

    Answer:<\/p>\n

    (1) Financial Leverage \\(=\\frac{\\text { EBIT }}{\\text { EBIT – Interest }}\\)
    \nFinancial Leverage (A Ltd.) \\(=\\frac{\\text { EBIT }}{\\text { EBIT }-20,000}\\) = 3 times
    \nEBIT = \u20b9 30,000
    \nFinancial Leverage (B Ltd.) \\(=\\frac{\\text { EBIT }}{\\text { EBIT }-1,00,000}\\) = 2 times
    \nEBIT = \u20b9 2,00,000<\/p>\n

    (2) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \nOperating Leverage (A Ltd.) \\(=\\frac{\\text { Contribution }}{30,000}\\) = 5 times
    \nContribution = \u20b9 1,50,000
    \nSales = \u20b9 1,50,000 \u00f7 40% (PV) = \u20b9 3,75,000
    \nOperating Leverage (B Ltd.) \\(=\\frac{\\text { Contribution }}{2,00,000}\\) = 2 times
    \nContribution = \u20b9 4,00,000
    \nSales = \u20b9 4,00,000 \u00f7 50% (PV) = \u20b9 8,00,000<\/p>\n

    (3) Contribution = EBIT + Fixed Cost
    \nContribution (A Ltd.) = 30,000 + Fixed Cost = \u20b9 1,50,000
    \nFixed cost = \u20b9 1,20,000
    \nContribution (B Ltd.) = 2,00,000 + Fixed Cost = \u20b9 4,00,00
    \nFixed cost = \u20b9 2,00,000<\/p>\n

    (4) Comment based on leverage: B Ltd. is better than A Ltd. having lower degree of Business risk, Financial risk and overall risk.<\/p>\n

    Question 17.
    \nThe following data have been extracted from the books of LM Ltd:<\/p>\n

    Sales : \u20b9 100 Lakhs
    \nInterest payable per annum : \u20b9 10 Lakhs
    \nOperating leverage : 1.2
    \nCombined leverage : 2.16<\/p>\n

    You are required to find out:<\/p>\n

    (1) The Financial leverage
    \n(2) Fixed cost and
    \n(3) P\/V ratio (5 Marks May 2018)<\/p>\n

    Answer:<\/p>\n

    (1) Financial Leverage = Combined leverage \u00f7 Operating leverage
    \n= 2.16 \u00f7 1.2 = 1.8 times<\/p>\n

    (2) Calculation of fixed cost:
    \nFinancial Leverage \\(=\\frac{\\text { EBIT }}{\\text { EBIT – Interest }}\\) = 1.8 times
    \n\\(=\\frac{\\text { EBIT }}{\\text { EBIT }-10,00,000}\\) = 1.8 times
    \nEBIT = \u20b9 22,50,000
    \nOperation Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = 1.2 times
    \nContribution = \u20b9 2,50,000 \u00d7 1.2 = \u20b9 27,00,000
    \nFixed cost = Contribution – EBIT
    \n= \u20b9 27,00,000 – 2,50,000 = \u20b9 4,50,000<\/p>\n

    (3) P\/V ratio = Contribution \u00f7 Sales
    \n= 27,00,000 \u00f7 1,00,00,000 = 27%<\/p>\n

    \"Financing<\/p>\n

    Question 18.
    \nFollowing is Balance Sheet of Soni Ltd. as on 31st March, 2018.
    \n\"Financing<\/p>\n

    Additional information:<\/p>\n

    Fixed cost per annum (excluding interest) : \u20b9 20,00,000
    \nVariable operating cost ratio : 60%
    \nTotal assets turnover ratio : 5 times
    \nIncome Tax rate : 25%<\/p>\n

    You are required to:<\/p>\n

    (1) Prepare Income Statement
    \n(2) Calculate the following and comment:<\/p>\n

    (a) Operating Leverage
    \n(b) Financial Leverage
    \n(c) Combined Leverage (10 Marks Nov. 2018)<\/p>\n

    Answer:<\/p>\n

    (1) Income Statement
    \n\"Financing<\/p>\n

    (2) Calculation of OL:
    \nOL \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = \\(\\frac{2,00,00,000}{1,80,00,000}\\) = 1.11 times<\/p>\n

    It indicates fixed cost in cost structure. It indicates sensitivity of earnings before interest and tax (EBIT) to change in sales at a particular level.<\/p>\n

    Calculation of FL:
    \nFL \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\) = \\(\\frac{1,80,00,000}{1,74,00,000}\\) = 1.03 times<\/p>\n

    The financial leverage is very comfortable since the debt service obli-gation is small vis-a-vis EBIT.
    \nCalculation of CL:
    \nCL = OL \u00d7 FL = 1.11 \u00d7 1.03 = 1.15 times
    \nThe combined leverage studied the choice of fixed cost in cost struc-ture and choice of debt in capital structure. It studies how sensitive the change in EPS is vis-a-vis change in sales.<\/p>\n

    Question 19.
    \nA company has sales of \u20b9 1,00,00,000; variable cost is 55% of sales and fixed cost is \u20b9 6,00,000. The capital structure of the company is: Equity \u20b9 20,00,000 and 8% Debt \u20b9 80,00,000.<\/p>\n

    Calculate:<\/p>\n

    (1) Operating, Financial and Combined Leverages.
    \n(2) If the sales amount is increased by 12%, by what percentage EBIT will increase? (5 Marks Nov. 2018)<\/p>\n

    Answer:<\/p>\n

    (1) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \n= \\(\\frac{1,00,00,000 \\times 45 \\%}{45,00,000-6,00,000}\\) = 1.154 times
    \nFinancial Leverage \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\)
    \n= \\(\\frac{39,00,000}{39,00,000-8 \\% \\text { of } 80,00,000}\\) = 1.196 times
    \nCombined Leverage = OL \u00d7 FL
    \n= 1.154 \u00d7 1.196 = 1.38 times<\/p>\n

    (2) % increase on EBIT:
    \n\u0394 EBIT (in %) = \u0394 sales \u00d7 DOL
    \n= 12% \u00d7 1.154
    \n= 13.84%<\/p>\n

    Question 20.
    \nThe capital structure of the Shiva Ltd. consists of an ordinary share capital of \u20b9 20,00,000 (share of \u20b9 100 par value) and \u20b9 20,00,000 of 10% debentures.<\/p>\n

    Sales increased by 20% from 2,00,000 units to 2,40,000 units, the selling price is \u20b9 10 per unit; variable cost amounts to \u20b9 6 per unit and fixed expenses amount to \u20b9 4,00,000.
    \nThe income tax rate is assumed to be 50%.<\/p>\n

    You are required to calculate the following:<\/p>\n

    (1) The percentage increase in earnings per share;
    \n(2) Financial leverage at 2,00,000 units and 2,40,000 units.
    \n(3) Operating leverage at 2,00,000 units and 2,40,000 units.
    \n(4) Comment on the behaviour of operating and financial leverages in relation to increase in production from 2,00,000 units to 2,40,000 units. (10 Marks May 2019)<\/p>\n

    Answer:<\/p>\n

    (1) Calculation of % increase in EPS
    \n\"Financing
    \n% increase in EPS = \\(\\frac{9.00-5.00}{5.00}\\) \u00d7 100 = 80%<\/p>\n

    (2) Financial Leverage \\(=\\frac{\\text { EBIT }}{\\text { EBT }}\\)
    \nAt 2,00,000 units = \\(\\frac{4,00,000}{2,00,000}\\) = 2 times
    \nAt 2,40,000 units = \\(\\frac{5,60,000}{3,60,000}\\) = 1.56 times<\/p>\n

    (3) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \nAt 2,00,000 units = \\(\\frac{8,00,000}{4,00,000}\\) = 2 times
    \nAt 2,40,000 units = \\(\\frac{9,60,000}{5,60,000}\\) = 1.71 times<\/p>\n

    (4) Increase in production and sales will result in decrease in risk<\/p>\n

    \"Financing<\/p>\n

    Question 21.
    \nThe balance sheet of Gitashree Ltd. is given below:
    \n\"Financing
    \nThe company\u2019s total assets turnover ratio is 4 times, its fixed operating cost is \u20b9 2,00,000 and its variable operating cost ratio is 60%. The income tax rate is 30%.<\/p>\n

    You are required to:<\/p>\n

    1. (a) Degree of Operating Leverage.
    \n(b) Degree of Financial Leverage.
    \n(c) Degree of Combined Leverage.<\/p>\n

    2. Determine the likely level of EBIT if EPS is
    \n(A) \u20b9 1.00,
    \n(B) \u20b9 2.00 and
    \n(C) \u20b9 Nil. (10 Marks Nov. 2019)<\/p>\n

    Answer:<\/p>\n

    1.
    \n(a) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = \\(\\frac{96,000}{76,000}\\) = 1.26
    \n(b) Financial Leverage \\(=\\frac{\\text { EBIT }}{\\mathrm{EBT}}\\) = \\(\\frac{76,000}{7,36,000}\\) = 1.03
    \n(c) Combined Leverage = OL \u00d7 FL = 1.26 \u00d7 1.03 = 1.30<\/p>\n

    2. Calculation of likely level of EBIT:
    \nEarnings Per Share \\(=\\frac{(\\mathrm{EBIT}-\\mathrm{I})(1-\\mathrm{t})}{\\mathrm{N}}\\)
    \n\"Financing<\/p>\n

    Working Note:<\/strong><\/p>\n

    Income statement
    \n\"Financing<\/p>\n

    Question 22.
    \nThe following data is available for Stone Ltd.:
    \n\"Financing<\/p>\n

    Using the concept of leverage, find out:<\/p>\n

    (i) The percentage change in taxable income if EBIT increases by 10%.
    \n(ii) The percentage change in EBIT if sales increases by 10%.
    \n(iii) The percentage change in taxable income if sales increases by 10%. Also verify the results in each of the above case. (10 Marks Nov. 2020)<\/p>\n

    Answer:<\/p>\n

    (i) % change in taxable income (EBT) = % increase in EBIT \u00d7 FL
    \n= 10% \u00d7 1.333 times = 13.33%
    \n(ii) % change in EBIT = % increase in Sales \u00d7 OL
    \n= 10% \u00d7 3 times = 30%
    \n(iii) % change in taxable income (EBT) = % increase in Sales \u00d7 CL
    \n= 10% \u00d7 4 times = 40%<\/p>\n

    Verification in each case:<\/p>\n

    (i) % change in taxable income if EBIT increases by 10%:
    \nRevised taxable income (EBT) = EBIT + 10% – Interest
    \n= 1,00,000 + 10% – 25,000 = 85,000
    \n% change in taxable income = \\(\\frac{85,000-75,000}{75,000}\\) \u00d7 100 = 13.33%<\/p>\n

    (ii) % change in EBIT if Sales increases by 10%:
    \nRevised EBIT = (Sales + 10%) – Variable cost @ 40% – Fixed cost
    \n= (5,00,000 + 10%) – 40% of 5,50,000 – 2,00,000
    \n= 1,30,000<\/p>\n

    (iii) % change in taxable income if Sales increases by 10%:
    \nRevised taxable income (EBT)
    \n= (Sales+10%) – Variable cost@40% – Fixed cost – Interest
    \n= (5,00,000 + 10%) – 40% of 5,50,000 – 2,00,000 – 25,000
    \n= 1,05,000
    \n% change in taxable income = \\(\\frac{1,05,000-75,000}{75,000}\\) \u00d7 100 = 40%<\/p>\n

    Working Note:<\/strong><\/p>\n

    (a) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \n= \\(\\frac{3,00,000}{1,00,000}\\) = 3 times<\/p>\n

    (b) Financial Leverage \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\)
    \n= \\(\\frac{1,00,000}{75,000}\\) = 1.333 times<\/p>\n

    (c) Combined Leverage = OL \u00d7 FL
    \n= 3 \u00d7 1.333 = 4 times<\/p>\n

    Question 23.
    \nThe following information related to XYZ Company Ltd. for the year ended 31st March, 2020 are as follows:<\/p>\n

    Equity share capital of \u20b9 100 each : \u20b9 50 Lakhs
    \n12% Bonds of \u20b9 1,000 each : \u20b9 30 Lakhs
    \nSales : \u20b9 84 Lakhs
    \nFixed cost (Excluding Interest) : \u20b9 7.5 Lakhs
    \nFinancial leverage : 1.39
    \nProfit Volume Ratio : 25%
    \nMarket Price per Equity Share : \u20b9 200
    \nIncome Tax Rate Applicable : 30%<\/p>\n

    You are required to calculate:<\/p>\n

    (i) Operating Leverage
    \n(ii) Combined Leverage
    \n(iii) Earning Per Share
    \n(iv) Earning Yield (10 Marks Jan. 2021)<\/p>\n

    Answer<\/p>\n

    (i) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \n= \\(\\frac{21,00,000}{13,50,000}\\) = 1.56 times<\/p>\n

    (ii) Combined Leverage = OL \u00d7 FL
    \n= 1.56 \u00d7 1.39 = 2.16 rimes<\/p>\n

    (iii) Earnings Per Share \\(=\\frac{\\text { PAT }}{\\text { No of Equity shares }}\\)
    \n= \\(\\frac{6,93,000}{50,000}\\) = \u20b9 13.86<\/p>\n

    (iv) Earnings Yield \\(=\\frac{E P S}{\\text { MPS }}\\) \u00d7 100
    \n= \\(\\frac{13.86}{200}\\) \u00d7 100 = 6.93%<\/p>\n

    Working Notes:<\/strong><\/p>\n

    (1) Contribution Sales \u00d7 PV Ratio
    \n= 84 Lakhs \u00d7 25% = 21,00,000<\/p>\n

    (2) EBIT = Contribution – Fixed Cost
    \n= 21,00,000 – 7,50,000 = 13,50,000<\/p>\n

    (3) Profit after tax = (EBIT – Interest) (1 – t)
    \n= (13,50,000 – 12% of 30,00,000) (1 – 0.30)
    \n= 6,93,000<\/p>\n

    \"Financing<\/p>\n

    Important Questions<\/strong><\/p>\n

    Question 1.
    \nZ Limited is considering the installation of a new project costing \u20b9 80,00,000. Expected annual sales revenue from the project is \u20b9 90,00,000 and its variable costs are 60 per cent of sales. Expected annual fixed cost other than interest is \u20b9 10,00,000. Corporate tax rate is 30 per cent. The company w’ants to arrange the funds through issuing 4,00,000 equity shares of \u20b9 10 each and 12 per cent debentures of \u20b9 40,00,000.<\/p>\n

    You are required to:<\/p>\n

    (i) Calculate the operating, financial and combined leverages and Earnings per Share (EPS).
    \n(ii) Determine the likely level of EBIT, if EPS is \u20b9 4, or \u20b9 2, or Zero.<\/p>\n

    Answer:<\/p>\n

    (i)
    \n\"Financing<\/p>\n

    (ii) Calculation of likely level of EBIT:
    \n\"Financing<\/p>\n

    Question 2.
    \nCalculate the operating leverage, financial leverage and combined leverage from the following data under situations I and II and financial plans A and B:<\/p>\n

    Installed capacity : 4,000 units
    \nActual production and sales : 75% of the Capacity
    \nSelling price : \u20b9 30 per unit
    \nVariable cost : \u20b9 15 per unit
    \nFixed cost:
    \nUnder situation I : \u20b9 15,000
    \nUnder situation II : \u20b9 20,000
    \n\"Financing
    \nAnswer:
    \nStatement of showing OL, FL and CL
    \n\"Financing<\/p>\n

    Question 3.
    \nThe capital structure of the Progressive Corporation consists of an ordi nary share capital of \u20b9 1,00,00,000 (share of \u20b9 100 par value) and \u20b9 10,00,000 of 10% debentures.<\/p>\n

    Sales increased by 20% from 1,00,000 units to 1,20,000 units, the selling price is \u20b9 10 per unit; variable cost amounts to \u20b9 6 per unit and fixed expenses amount to \u20b9 2,00,000.<\/p>\n

    The income tax rate is assumed to be 50%.<\/p>\n

    You are required to calculate the following:<\/p>\n

    (i) The percentage increase in earnings per share;
    \n(ii) The degree of operating leverage at 1,00,000 units and 1,20,000 units.
    \n(iii) The degree of financial leverage at 1,00,000 units and 1,20,000 units.
    \n(iv) Comment on the behaviour of operating and financial leverages in relation to increase in production from 1,00,000 units to 1,20,000 units.<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of % increase in EPS
    \n\"Financing
    \n% increase in EPS = \\(\\frac{0.90-0.50}{0.50}\\) \u00d7 100 = 80%<\/p>\n

    (ii) Degree of Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\)
    \nAt 1,00,000 units = \\(\\frac{4,00,000}{2,00,000}\\) = 2 times
    \nAt 1,20,000 units = \\(\\frac{4,80,000}{2,80,000}\\) = 1.71 times<\/p>\n

    (iii) Degree of Financial Leverage \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\)
    \nAt 1,00,000 units = \\(\\frac{2,00,000}{1,00,000}\\) = 2 times
    \nAt 1,20,000 units = \\(\\frac{2,80,000}{1,80,000}\\) = 1.56 times
    \n(iv) Increase in production and sales will result in decrease in risk.<\/p>\n

    \"Financing<\/p>\n

    Question 4.
    \nA company had the following Balance Sheet as on March 31, 2006
    \n\"Financing
    \nThe additional information given is as under:
    \nFixed costs per annum (excluding interest) : \u20b9 8 Crores
    \nVariable operating costs ratio : 65% of sales
    \nTotal Assets turnover ratio : 2.5 times
    \nIncome tax rate : 40%<\/p>\n

    Calculate<\/p>\n

    (i) Earnings per share,
    \n(ii) Operating Leverage,
    \n(iii) Financial Leverage,
    \n(iv) Combined Leverage and comment on all leverages.<\/p>\n

    Answer:<\/p>\n

    (i) Statement of EPS
    \n\"Financing
    \n\"Financing<\/p>\n

    (ii) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) \\(=\\frac{35 \\text { Crores }}{27 \\text { Crores }}\\) = 1.296 times
    \nIt indicates fixed cost in cost structure. It indicates sensitivity of earnings before interest and tax (EBIT) to change in sales at a particular level.<\/p>\n

    (iii) Financial Leverage \\(=\\frac{\\mathrm{EBIT}}{\\mathrm{EBT}}\\) \\(=\\frac{27 \\text { Crores }}{24 \\text { Crores }}\\) = 1.125 times
    \nThe financial leverage is very comfortable since the debt service obli-gation is small vis-a-vis EBIT.<\/p>\n

    (iv) Combined Leverage = OL \u00d7 FL = 1.296 \u00d7 1.125 = 1.458 times<\/p>\n

    The combined leverage studies the choice of fixed cost in cost structure and choice of debt in capital structure. It studies how sensitive the change in EPS is vis-a-vis change in sales.<\/p>\n

    \"Financing<\/p>\n

    Question 5.
    \nFrom the following information, prepare Income Statement of Company A & B:<\/p>\n\n\n\n\n\n\n\n\n
    Particulars<\/td>\nCompany A<\/td>\nCompany B<\/td>\n<\/tr>\n
    Margin of safety<\/td>\n0.20<\/td>\n0.25<\/td>\n<\/tr>\n
    Interest<\/td>\n\u20b9 3.000<\/td>\n\u20b9 2,000<\/td>\n<\/tr>\n
    Profit volume ratio<\/td>\n25%<\/td>\n33.33%<\/td>\n<\/tr>\n
    Financial Leverage<\/td>\n4<\/td>\n3<\/td>\n<\/tr>\n
    Tax rate<\/td>\n45%<\/td>\n45%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Answer:
    \nIncome Statement
    \n\"Financing
    \n\"Financing<\/p>\n

    (a) Company A:
    \nFinancial Leverage = EBIT\/(EBIT – Interest)
    \n= EBIT\/(EBIT – \u20b9 3,000) = 4 times
    \nEBIT = 4 EBIT – \u20b9 12,000
    \nEBIT = \u20b9 4,000<\/p>\n

    Company B:
    \nFinancial Leverage = EBIT\/(EBIT – Interest)
    \n= EBIT\/(EBIT – \u20b9 2,000) = 3 times
    \nEBIT = 3 EBIT – \u20b9 6,000
    \nEBIT = \u20b9 3,000<\/p>\n

    (b) Company A:
    \nOperating Leverage = 1\/Margin of Safety
    \n1\/0.20 = 5 times
    \nOperating Leverage = Contribution\/EBIT
    \n= Contribution\/\u20b9 4,000 = 5 times
    \nContribution = \u20b9 20,000
    \nCompany B:
    \nOperating Leverage = 1\/ Margin of Safety
    \n= 1\/0.25 4tirncs
    \nOperating Leverage = Contnbution\/EBIT
    \n= Contribution\/\u20b9 3,000 = 4 times
    \nContribution = \u20b9 12,000<\/p>\n

    (c) company A:
    \nSales = Contribution\/PV Ratio
    \n= \u20b9 20,000\/0.25 = \u20b9 80,000<\/p>\n

    company B:
    \nSales = Contribution\/PV Ratio
    \n= \u20b9 20,000\/0.3333 = \u20b9 36,000<\/p>\n

    Question 6.
    \nA firm has sales of \u20b9 75,00,000 variable cost is 56% and fixed cost is \u20b9 6,00,000. It has a debt of \u20b9 45,00,000 at 9% and equity of \u20b9 55,00,000.<\/p>\n

    (i) What is the firm\u2019s ROI?
    \n(ii) Does it have favourable financial leverage?
    \n(iii) If the firm belongs to an industry whose capital turnover is 3, does it have a high or low capital turnover?
    \n(iv) What are the operating, financial and combined leverages of the firm?
    \n(v) If the sales is increased by 10% by what percentage EBIT will increase?
    \n(vi) At what level of sales the EBT of the firm will be equal to zero?
    \n(vii) If EBIT increases by 20%, by what percentage EBT will increase?<\/p>\n

    Answer:<\/p>\n

    Income Statement
    \n\"Financing<\/p>\n

    (i) ROI \\(=\\frac{\\text { EBIT }}{\\text { Capital Employed }}\\) \u00d7 100
    \n= \\(\\frac{27,00,000}{45,00,000+55,00,000}\\) \u00d7 100 = 27%<\/p>\n

    (ii) ROI is 27% and Interest on debt is 9%, hence, it has a favourable financial leverage.<\/p>\n

    (iii) Capital Turnover \\(=\\frac{\\text { Net Sales }}{\\text { Capital }}\\) = \\(\\frac{75,00,000}{1,00,00,000}\\) = 0.75
    \nFirm has very low capital turnover as compared to industry average of 3.<\/p>\n

    (iv) Calculation of Operating, Financial and Combined leverages:
    \nOperating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) = \\(\\frac{33,00,000}{27,00,000}\\) = 1.222
    \nFinancial Leverage \\(=\\frac{\\text { EBIT }}{\\text { EBT }}\\) = \\(\\frac{27,00,000}{22,95,000}\\) = 1.176
    \nCombined Leverage = OL \u00d7 FL = 1.222 \u00d7 1.176 = 1.437<\/p>\n

    (v) Operating leverage is 1.22. So if sales is increased by 10% then EBIT will be increased by 1.222 \u00d7 10 i.e. 12.22% (approx)<\/p>\n

    (vi) EBT = Sales – Variable cost – Fixed cost – Interest
    \nNil = Sales – 56% sales – 6,00,000 – 4,05,000
    \n44% of sales = 10,05,000
    \nSales = 22,84,091
    \nHence at \u20b9 22,84,091 sales level EBT of the firm will be equal to Zero.<\/p>\n

    (vii) Financial leverage is 1.176. So, if EBIT increases by 20% then EBT will increase by 1.18 \u00d7 20% = 23.52% (approx)<\/p>\n

    \"Financing<\/p>\n

    Question 7.
    \nYou are given the following information of 5 firms of the same industry:<\/p>\n\n\n\n\n\n\n\n\n
    Finn<\/td>\nChange in Revenue<\/td>\nChange in Operating Income<\/td>\nChange in EPS<\/td>\n<\/tr>\n
    M<\/td>\n28%<\/td>\n26%<\/td>\n32%<\/td>\n<\/tr>\n
    N<\/td>\n27%<\/td>\n34%<\/td>\n26%<\/td>\n<\/tr>\n
    P<\/td>\n25%<\/td>\n38%<\/td>\n23%<\/td>\n<\/tr>\n
    0<\/td>\n23%<\/td>\n43%<\/td>\n27%<\/td>\n<\/tr>\n
    R<\/td>\n25%<\/td>\n40%<\/td>\n28%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Find out:<\/p>\n

    (a) Degree of operating leverage, and
    \n(b) Degree of combined leverage of all the firms.<\/p>\n

    Answer:<\/p>\n

    (a) Degree of Operating Leverage \\(=\\frac{\\% \\text { Change in operating income }}{\\% \\text { Change in revenue }}\\)
    \nM = 26% \u00f7 28% = 0.93
    \nN = 34% \u00f7 27% = 1.26
    \nP = 38% \u00f7 25% = 1.52
    \nQ = 43% \u00f7 23% = 1.87
    \nR = 40% \u00f7 25% = 1.60<\/p>\n

    (b) Degree of Combined Leverage \\(=\\frac{\\% \\text { Change in EPS }}{\\% \\text { Change in revenue }}\\)
    \nM = 32% \u00f7 28% = 1.14
    \nN = 26% \u00f7 27% = 0.96
    \nP = 23% \u00f7 25% = 0.92
    \nQ = 27% \u00f7 23% = 1.17
    \nR = 28% \u00f7 25% = 1.12<\/p>\n

    Question 8.
    \nThe net Sales of A Ltd. is \u20b9 30 crores. Earning before interest and tax of the company as a percentage of net sales is 12%. The capital employed comprises \u20b9 10 crores of Equity, \u20b9 2 crores of 13% Cumulative Preference Share Capital and 15% Debentures of \u20b9 6 crores. Income tax rate is 40%.<\/p>\n

    Required:<\/p>\n

    (i) Calculate the Return on Equity (ROE) for the Company and indicate its segments due to the presence of Preference Share Capital and Bor rowing (Debentures).
    \n(ii) Calculate the Operating Leverage of the Company given that its Combined Leverage is 3.<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of ROE :
    \nROE \\(=\\frac{\\text { Earnings for Equity Shareholders }}{\\text { Equity Shareholder’s Fund }}\\) \u00d7 100
    \n\\(=\\frac{1.36 \\text { Crores }}{10 \\text { Crores }}\\) \u00d7 100 = 13.60%<\/p>\n

    Segment:<\/p>\n

    ROCE\/ROI \\(=\\frac{\\text { EBIT }}{\\text { Capital Employed }}\\) \u00d7 100
    \n\\(=\\frac{3.60 \\text { crores }}{18 \\text { crores }}\\) \u00d7 100 = 20%
    \nSegment due to Preference Share Capital
    \n= [20% (1 – 40) – 13%] \u00d7 \\(\\frac{2}{10}\\) = -20%
    \nSegment due to Debentures
    \n= [(20% – 15%) (1 -40)] \u00d7 \\(\\frac{6}{10}\\) = 1.80%
    \nReturn on Equity with segment effect
    \n= ROI (1-t) -.20% + 1.80%
    \n= [20% (1-.40)] -.20% + 1.80% = 13.60%<\/p>\n

    (ii) Operating Leverage = Combined Leverage \u00f7 Financial Leverage
    \n= 3 times \u00f7 1.59 times = 1.89 times<\/p>\n

    Working Notes:<\/strong><\/p>\n

    1. Calculation of Earnings Available for Equity Shareholders
    \n\"Financing<\/p>\n

    2. Calculation of Financial Leverage:
    \nFinancial Leverage \\(=\\frac{\\text { EBIT }}{\\text { EBT }-\\frac{\\text { Preference Dividend }}{1-\\text { Tax }}}\\)
    \n\\(=\\frac{3,60,00,000}{2,70,00,000-\\frac{26,00,000}{1-0.40}}\\) = 1.59 times<\/p>\n

    Question 9.
    \nThe following details of RST Limited for the year ended 31 March, 2006 are given below:<\/p>\n

    Operating leverage : 1.4 times
    \nCombined leverage : 2.8 times
    \nFixed Cost (Excluding interest) : \u20b9 2.04 lakhs
    \nSales : \u20b9 30.00 lakhs
    \n12% Debentures of \u20b9 100 each : \u20b9 21.25 lakhs
    \nEquity Share Capital of \u20b9 10 each : \u20b9 17.00 lakhs
    \nIncome tax rate : 30 per cent<\/p>\n

    Required:<\/p>\n

    (i) Calculate Financial Leverage.
    \n(ii) Calculate P\/V ratio and Earning Per Share (EPS).
    \n(iii) If the company belongs to an industry, whose assets turnover is 1.5, does it have a high or low assets turnover?
    \n(iv) At what level of sales the Earning before Tax (EBT) of the company will be equal to zero?<\/p>\n

    Answer:<\/p>\n

    (i) Calculation of Financial Leverage:
    \nFinancial Leverage = CL \u00f7 OL = 2.80 \u00f7 1.40 = 2 times<\/p>\n

    (ii) P\/V Ratio and EPS:
    \np\/v ratio \\(=\\frac{\\text { Contribution }}{\\text { Sales }}\\) \u00d7 1oo = \\(\\frac{7,14,000}{30,00,000}\\) \u00d7 100 = 23.80%
    \nEPS \\(=\\frac{\\text { PAT }}{\\text { No. of Shares }}\\) = \\(\\frac{1,78,500}{1,70,000}\\) = \u20b9 1.05
    \nCalculation of contribution:
    \nOperating leverage \\(=\\frac{\\text { Contribution }}{\\text { Contribution }-\\mathrm{FC}}\\)
    \n\\(=\\frac{\\text { Contribution }}{\\text { Contribution }-2,04,000}\\) = 1.4 times
    \n1.4 Contribution – 2,85,600 = Contribution = 7,14,000
    \nCalculation of PAT:
    \nProfit after tax (Contribution – fixed cost – interest) (1 – t)
    \n= (23.80% of 30 lacs – 2.04 lacs – 12% of 21.25 lacs)(1 – 0.30)
    \n= 1,78,500<\/p>\n

    (iii) Assets turnover:
    \nAssets turnover \\(=\\frac{\\text { Sales }}{\\text { Total Assets }}\\) = \\(\\frac{30,00,000}{38,25,000}\\) = .784
    \n0.784 < 1.5 means lower than industry assets turnover.<\/p>\n

    (iv) Level of sales to earn zero EBT:
    \nEBT = Sales – Variable cost – Fixed cost – Interest
    \nNil = Sales – 76.20% sales – 2,04,000 – 2,55,000
    \n23.80% of sales = 4,59,000
    \nSales = 19,28,571<\/p>\n

    \"Financing<\/p>\n

    Question 10.
    \nThe capital structure of JCPL Ltd. is as follows:<\/p>\n

    Equity share capital of \u20b9 10 each : \u20b9 8,00,000
    \n8% Preference share capital of \u20b9 10 each : \u20b9 6,25,000
    \n10% Debenture of \u20b9 100 each : \u20b9 4,00,000<\/p>\n

    Additional Information:<\/p>\n

    Profit after tax (tax rate 30%) : \u20b9 1,82,000
    \nOperating expenses (including depreciation \u20b9 90,000) : 1.50 times of EBIT
    \nEquity share dividend paid : 15%
    \nMarket price per equity share : \u20b9 20.00<\/p>\n

    Required to calculate:<\/p>\n

    (i) Operating and financial leverage.
    \n(ii) Cover the preference and equity share dividends.
    \n(iii) The earning yield and price earning ratio.
    \n(iv) The net fund flow.<\/p>\n

    Answer:<\/p>\n

    (i) Operating & Financial leverage:
    \n\"Financing<\/p>\n

    (ii) Calculation of cover the preference & equity share dividends:
    \nCover the Preference Share Dividend
    \n\"Financing
    \nCover the Equity Share Dividend
    \n\"Financing<\/p>\n

    (iii) Earning yield & price earning ratio:
    \n\"Financing<\/p>\n

    (iv) Net fund flow:
    \nNet fund flow = PAT – Preference dividends – Equity dividends + Depreciation
    \n= 1,82,000 – 50,000 – 1,20,000 + 90,000 = \u20b9 1,02,000
    \nCalculation of contribution:
    \n\"Financing<\/p>\n","protected":false},"excerpt":{"rendered":"

    Financing Decisions-Leverages \u2013 CA Inter FM Study Material is designed strictly as per the latest syllabus and exam pattern. Financing Decisions-Leverages \u2013 CA Inter FM Study Material Theory Questions Question 1. Distinguish between business risk and financial risk or \u201cOperating risk is associated with cost structure, whereas financial risk is associated with capital structure of …<\/p>\n

    Financing Decisions-Leverages \u2013 CA Inter FM Study Material<\/span> Read More »<\/a><\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"spay_email":"","footnotes":""},"categories":[167],"tags":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/16579"}],"collection":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/comments?post=16579"}],"version-history":[{"count":10,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/16579\/revisions"}],"predecessor-version":[{"id":16897,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/16579\/revisions\/16897"}],"wp:attachment":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/media?parent=16579"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/categories?post=16579"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/tags?post=16579"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}