Q1. A FIRM HAS SALES OF RS. 10,00,000 , VARIABLE COST IS 70% , TOTAL COST IS RS.

9,00,000 AND 10% DEBT OF RS. 5,00,000. IF TAX = 40% CALCULATE : (A) (B) (C) (D) Sol :OPERATING LEVERAGE. FINANCIAL LEVERAGE. COMBINED LEVERAGE. IF THE FIRM WANTS TO DOUBLE ITS EBIT, HOW MUCH OF A RAISE IN SALES WOULD BE NEEDED ON A % BASIS ? INCOME STATEMENT PARTICULARS SALES LESS : VARIABLE COST ( 70% OF 10,00,000 ) CONTRIBUTION LESS : FIXED COST ( TOTAL COST VARIABLE COST i.e 9,00,000 - 7,00,000 ) EBIT LESS : INTEREST ( 10% OF 5,00,000 ) NPBT LESS : TAX @ 40% NPAT AMOUNT RS. 10,00,000 7,00,000

3,00,000 2,00,000

1,00,000 50,000 50,000 20,000 30,000

(A) OPERATING LEVERAGE :

CONTRIBUTION EBIT

= 3,00,000 1,00,000 = 3 Times (B) FINANCIAL LEVERAGE : EBIT NPBT = 1,00,000 50,000 = 2 Times (C) COMBINED LEVERAGE : CONTRIBUTION NPBT = 3,00,000 50,000 = 6 Times

(D) CALCULATION OF % CHANGE IN SALES CONTRIBUTION EBIT 3 = = % CHANGE IN EBIT % CHANGE IN SALES 100 % CHANGE IN SALES

% CHANGE IN SALES

100 3

33.33%

NEW SALES = ( 100 + 33.33% ) x = 133.33% X

RS. 10,00,000.

RS . 10,00,000.

= RS. 13,33,3000

Q2. CALCULATE OPERATING , FINANCIAL AND COMBINED LEVERGRS. 01. OUTPUT = 15,000 UNITS 02. TOTAL OPERATING COST = 3,65,000 03. VARIABLE COST PER UNIT = 30% OF SELLING PRICE 04. 10% BORROWED CAPITAL = RS. 8,00,000 05. SELLING PRICE PER UNIT = RS. 50 06. TAX = 40% Sol :INCOME STATEMENT PARTICULARS SALES ( 15,000 X RS. 50 PER UNIT ) LESS : VARIABLE COST ( 30% OF Rs. 50 = 15 X 15,000 ) CONTRIBUTION LESS : FIXED COST ( TOTAL COST VARIABLE COST i.e 3,65,000 - 2,25,000 ) EBIT LESS : INTEREST ( 10% OF 8,00,000 ) NPBT LESS : TAX @ 40% NPAT AMOUNT RS. 7,50,000 2,25,000

5,25,000 1,40,000

3,85,000 80,000 3,05,000 1,22,000 1,83,000

(A) OPERATING LEVERAGE :

CONTRIBUTION EBIT

= 5,25,000 3,85,000 = 1.36 Times (B) FINANCIAL LEVERAGE : EBIT NPBT = 3,85,000 3,05,000 = 1.26 Times (C) COMBINED LEVERAGE : CONTRIBUTION NPBT = 5,25,000 3,05,000 = 1.72 Times

Q3. A FIRMS SALES = RS. 75,00,000 , VARIABLE COSTS = RS. 42,00,000 , & FIXED COST = RS. 6,00,000. IT HAS 9% DEBT = RS. 45,00,000 & ITS EQUITY WAS RS. 55,00,000 & TAX = 35%. 01. DEGREE OF OPERATING LEVERAGE. 02. DEGREE OF FINANCIAL LEVERAGE. 03. COMBINED LEVERAGE 04. NEW EBIT IF SALES = RS. 50,00,000. Sol :INCOME STATEMENT PARTICULARS SALES LESS : VARIABLE COST CONTRIBUTION LESS : FIXED COST AMOUNT RS. 75,00,000 42,00,000 33,00,000 6,00,000

EBIT LESS : INTEREST ( 9% OF 45,00,000 ) NPBT LESS : TAX @ 35% NPAT

27,00,000 4,05,000 22,95,000 8,03,250 14,91,750

(A) OPERATING LEVERAGE :

CONTRIBUTION EBIT

= 33,00,000 27,00,000 = 1.22 Times (B) FINANCIAL LEVERAGE : EBIT NPBT = 27,00,000 22,95,000 = 1.17 Times (C) COMBINED LEVERAGE : CONTRIBUTION NPBT = 33,00,000 22,95,000 = 1.43 Times

(D) NEW EBIT IF SALES = RS. 50,00,000 CONTRIBUTION EBIT 1.22 = = % CHANGE IN EBIT % CHANGE IN SALES % CHANGE IN EBIT 50,00,000 - 75,00,000 75,00,000

% CHANGE IN EBIT

( 25 X 1.22 ) X 100

40.66%

NEW EBIT = ( 100 40.66% ) x = 59.34% X

RS. 27,00,000.

RS . 27,00,000.

= RS. 16,02,180

Q4. CURRENT BALANCE SHEET OF ABC LTD LIABILITIES EQUITY @ 10 10% DEBT RETAINED EARNINGS CURRENT LIABILITIES TOTAL AMOUNT RS 8,00,000 6,00,000 3,50,000 1,50,000 19,00,000

ASSETS FIXED ASSETS CURRENT ASSETS TOTAL

AMOUNT RS 10,00,000 9,00,000 19,00,000

CURRENT INCOME STATEMENT OF ABC LTD PARTICULARS AMOUNT RS. SALES OPERATING EXPENSES ( INCLUDING DEPRECIATION RS. 60,000) EBIT LESS : INTEREST 3,40,000 1,20,000 2,20,000 60,000

EBT LESS : TAXES NET INCOME

1,60,000 56,000 1,04,000

(A) DETERMINE ALL LEVERGES. (B) ASSUMING TOTAL ASSETS TO BE THE SAME WHAT WILL BE THE EPS IF SALES CHANGE BY 20%. Sol :INCOME STATEMENT PARTICULARS SALES LESS : VARIABLE COST ( 1,20,000 60,000 ) CONTRIBUTION LESS : FIXED COST ( LESS DEPRECIATION 60,000 ) EBIT LESS : INTEREST ( 10% OF 6,00,000 ) NPBT LESS : TAX @ 34% AMOUNT RS. 3,40,000 60,000

2,80,000 60,000

2,20,000 60,000 1,60,000 56,000

NPAT NO. OF EQUITY SHARES EPS

1,04,000 80,000 1.3 Times

(A) OPERATING LEVERAGE :

CONTRIBUTION EBIT

= 2,80,000 2,20,000 = 1.27 Times (B) FINANCIAL LEVERAGE : EBIT NPBT = 2,20,000 1,60,000 = 1.37 Times (C) COMBINED LEVERAGE : CONTRIBUTION NPBT = 2,80,000 1,60,000 = (D) 1.75 Times

CALCULATION OF EPS

CONTRIBUTION NPAT

% CHANGE IN EPS % CHANGE IN SALES

2,80,000 1,04,000

% CHANGE IN EPS 20

% CHANGE IN EPS

= 20 X 2.69 = 53.8%

IF SALES INCREASES BY 20% NEW EPS = 100% + 53.8% = 153.8% X 1.3 = 2.0644 Times

IF SALES DECREASES BY 20% NEW EPS = 100% - 53.8% = 46.2% X 1.3 = 0.5356 Times

Q5. CURRENT BALANCE SHEET OF ABC LTD

LIABILITIES EQUITY @ 10 10% DEBT RETAINED EARNINGS CURRENT LIABILITIES TOTAL

AMOUNT RS 60,000 80,000 20,000 40,000 2,00,000

ASSETS FIXED ASSETS CURRENT ASSETS TOTAL ASSET TURNOVER = 3 FIXED COST = RS. 1,00,000 VARIABLE COST = 40% TAXES = 35% (A) ALL LEVERGES.

AMOUNT RS. 1,50,000 50,000 2,00,000

Sol :-

INCOME STATEMENT PARTICULARS AMOUNT RS. 6,00,000 2,40,000

SALES { 3 = SALES/2,00,000 } LESS : VARIABLE COST ( 40% OF 6,00,000 ) CONTRIBUTION LESS : FIXED COST EBIT LESS : INTEREST ( 10% OF 80,000 ) NPBT LESS : TAX @ 35% NPAT NO. OF EQUITY SHARES EPS

3,60,000 1,00,000 2,60,000 8,000 2,52,000 88,200 1,63,800 6,000 27.3 Times

(A) OPERATING LEVERAGE :

CONTRIBUTION EBIT

= 3,60,000 2,60,000 = 1.38 Times

(B) FINANCIAL LEVERAGE : EBIT NPBT = 2,60,000 2,52,000 = 1.03 Times (C) COMBINED LEVERAGE : CONTRIBUTION NPBT = 3,60,000 2,52,000 = 1.42 Times

Q6. THE BALANCE SHEET OF T LTD ON 31.03.2008 IS AS UNDER (LACS) LIABILITIES EQUITY CAPITAL @ RS.10 10% DEBT RETAINED EARNINGS CURRENT LIABILITIES TOTAL ASSETS BUILDING MACHINERY STOCK DEBTORS CASH TOTAL AMOUNT RS 90 120 30 60 300 AMOUNT RS 150 75 50 20 5 300

THE TOTAL ASSETS TURNOVER IS 3 , FIXED COST IS 1/6TH OF SALES AND VARIABLES COSTS ARE 50% OF SALES. TAX = 35% CALCULATE (A) ALL LEVERAGES (B) THE MARKET PRICE OF THE SHARES IF THE P/E RATIO IS 2.5 TIMES

Sol :-

INCOME STATEMENT PARTICULARS AMOUNT RS. ( IN LAKHS) 900 450

SALES { 3 = SALES/ 300 } LESS : VARIABLE COST ( 50% OF 900 ) CONTRIBUTION LESS : FIXED COST ( 1/6TH OF 900 ) EBIT LESS : INTEREST ( 10% OF 120 ) NPBT LESS : TAX @ 35% NPAT NO. OF EQUITY SHARES EPS P/E MARKET PRICE

450 150

300 12 288 100.8 187.2 9 20.8 Times 2.5 Times 52

(A) OPERATING LEVERAGE :

CONTRIBUTION EBIT

= 450 300 = 1.5 Times (B) FINANCIAL LEVERAGE : EBIT NPBT = 300 288 = 1.04 Times (C) COMBINED LEVERAGE : CONTRIBUTION NPBT = 450 288 = 1.56 Times

CASE STUDY

A COMPANY HAS ASSESTS OF RS. 10,00,000 FINANCED WHOLLY BY EQUITY SHARE CAPITAL. THERE ARE 10,00,000 SHARES OUTSTANDING WITH A BOOK VALUE OF RS. 10 PER SHARE. LAST YEARS PROFIT BEFORE TAXES WAS RS. 2,50,000. THE TAX RATE IS 35 PER CENT. THE COMPANY IS THINKING OF AN EXPANSION PROGRAMME THAT WILL COST RS. 5,00,000 THE FINANCIAL MANAGER CONSIDERS THE THREE FINANCING PLANS : (I) SELLING 50,000 SHARES AT RS. 10 PER SHARE (II) BORROWING RS. 5,00,000 AT AN INTEREST RATE OF 14 PER CENT (III) SELLING RS. 5,00,000 OF PREFERENCE SHARES WITH A DIVIDEND RATE OF 14 PER CENT. THE PROFIT BEFORE INTEREST AND TAX ARE ESTIMATED TO BE RS. 3,75,000 AFTER EXPANSION. CALCULATE : (I) (II) (III) THE AFTER-TAX RATE OF RETURN ON ASSET, THE EARNINGS PER SHARE THE RATE OF RETURN ON SHAREHOLDERS EQUITY FOR EACH OF THE THREE FINANCING ALTERNATIVES. ALSO SUGGEST WHICH ALTERNATIVE SHOULS BE ACCEPTED BY THE FIRM.

SOL :PARTICULARS PLAN - I EQUITY EBIT LESS: INTEREST EBT LESS: TAX @ 35% NPAT LESS: PREFERENCE DIV. RETAINED EARNINGS NO. OF EQUITY SHARES EPS 3,75,000 3,75,000 ( 1,31,250 ) 2,43,750 2,43,750 1,50,000 1.63 PLAN - II DEBT 3,75,000 ( 70,000 ) 3,05,000 ( 1,06,750 ) 1,98,250 1,98,250 1,00,000 1.98 PLAN - III PREF. SHARES 3,75,000 3,75,000 ( 1,31,250 ) 2,43,750 ( 70,000 ) 1,73,750 1,00,000 1.74

COMMENT : AS THE EPS IN PLAN II IS HIGHEST THAN OTHER PLANS , ITS PREFERABLE TO GO WITH PLAN-II i.e BORROWING RS. 5,00,000 AT AN INTEREST RATE OF 14 PER CENT