ASSIGNMENT LEVERAGES CA RAJESH AHUJA

CA INTER (FCA, CS, RV, FXTM, B.COM)

Question 1 A company operates at a production level of 5,000 units .The contribution

is Rs. 60 per unit ,operating leverage is 6. Combined leverage is 24. If tax rate is 30%
,what would be its earnings after tax ?
(CA PE-II June 2009)
Ans: 8750/-

Question 2: A firm has Sales of Rs.40 lakhs; Variable cost of Rs.25 lakhs; Fixed cost
of Rs.6 lakhs; 10% debts of Rs.30 lakhs; and Equity Capital of Rs.45 lakhs. Required:
Calculate operating and financial leverage.
(CA PCC Nov 2007)
Ans: 1.667, 1.50

Question 3 A simplified income statement of Zenith is given below :

Zenith Limited
Income Statement for the year ending March 31,1998

Sales 10,50,000
Variable cost 7,67,000
Fixed cost 75,000
EBIT 2,08,000
Interest 1,10,000
Taxes(30%) 29,400
Net income 68,600

Calculate and interpret the following :

(i) Degree of operating leverage
(ii) Degree of financial leverage
(iii) Degree of combined leverage
Ans: 1.36, 1.50, 2.88

Question 4: The following data relate to RT Ltd:

Rs.
Earning before interest and tax (EBIT) 10,00,000
Fixed cost 20,00,000
Earning Before Tax (EBT) 8,00,000

Compute various types of Leverages. (CA PCC May 2008)

Ans: 3, 1.25, 3.75

Question 5: Annual sales of a company is Rs.60,00,000. Sales to variable cost ratio

is 150 percent and fixed cost other than interest is Rs.5,00,000 per annum. Company
has 11 percent debentures of Rs.30,00,000. You are required to calculate the
operating, Financial and combined leverage of the company.(CAPE II Nov 2008)
Ans: 1.333, 1.2821, 1.7094
Question 6: Calculate the degree of operating leverage, degree of financial leverage
and the degree of combined leverage for the following firms and interpret the results:

P Q R
Output (units) 2,50,000 1,25,000 7,50,000
Fixed Cost (Rs.) 5,00,000 2,50,000 10,00,000
Units Variable Cost (Rs.) 5 2 7.50
Unit Selling Price (Rs.) 7.50 7 10.0
Interest Expense (Rs.) 75,000 25,000 -
(CA IPCC Nov. 2010)
Ans: 5,1.67, 2.14 2.5,1.07,NA 1.25, 0.79, 2.14

Question 7: A company operates at a production level of 1,000 units. The contribution

is Rs.60 per unit, operating leverage is 6, combined leverage is 24. If tax rate is 30%,
what would be its earnings after tax? (CA PCC Nov 2008)
Ans: 1750/-

Question 8: The Net Sales of Apex Co. are Rs.15 crores. EBIT of the Company as a
percentage of Net Sales is 12%. The Capital Employed comprises Rs.5 crores of
equity and Debt Capital of Rs.3 crores at an annual interest rate of 15%. Corporate
Income Tax Rate is 40%. Calculate the Operating Leverage of the Company given
that its Combined Leverage is 3.
Ans: 2.25

Question 9: XYZ Ltd. has an average selling price of 7 10 per unit. Its variable unit
costs are Rs.7, and fixed costs amount to Rs.1,70,000. It finances all its assets by
equity funds. It pays 35% tax on its income.
ABC Ltd. is identical of XYZ Ltd. except in the pattern of financing. The latter finances
its assets 50% by debt, the interest on which amounts to Rs.20,000.
Determine the degree of operating, financial and combined leverage at Rs.7,00,000
sales for both the firms, and interpret the results.
Ans: 5.25, 1, 5.25 5.25, 2, 10.50

Question 10: The data relating to two Companies are as given below:

Company A Company B
Equity Capital Rs.6,00,000 Rs.3,50,000
12% Debentures Rs.4,00,000 Rs.6,50,000
Output (units) per annum 60,000 15,000
Selling price/ unit Rs.30 Rs.250
Fixed Costs per annum Rs.7,00,000 Rs.14,00,000
Variable Cost per unit Rs.10 Rs.75

You are required to calculate the Operating leverage, Financial leverage and
Combined leverage of two Companies. (CA PE II Nov 2002)
Ans: 2.40, 1.11, 2.66 2.14, 1.07, 2.29

Question 11 The following information is available for AMD Ltd.

PBDIT Rs.8.30 Cr.
 Depreciation Rs.6 Cr.
Effective tax rate 30%
EPS Rs.4
Book value Rs.30 per share.
Number of outstanding shares 33 Cr.
D / E ratio 1.5:1
Find: -
a. Degree of financial Leverage.
b. Financial Break even point.
Ans: 4.37 635.43CR.

Question 12: From the following financial data of Company A and Company B:
Prepare their Income Statements. (Rs.)

Company A Company B
Variable Cost 56,000 60% of sales
Fixed Cost 20,000 --
Interest Expenses 12,000 9,000
Financial Leverage 5:1 --
Operating Leverage -- 4 :1
Income Tax Rate 30% 30%
Sales - 1,05,000
(CA PCC Nov. 2009)
Ans: Sales A – 91000, EAT A- 2100 EAT B- 1050

Question 13: Alpha Ltd. has furnished the following Balance Sheet as on March 31, 2011:
Liabilities Amount in (Rs.) Assets Amount in
(Rs.)
Equity Share Capital 10,00,000 Fixed Assets 30,00,000
(1,00,000)
(Equity share of Rs. 10 each Current 18,00,000
Assets
General Reserve 2,00,000
15% debentures 28,00,000
Current Liabilities 8,00,000
48,00,000 48,00,000

Additional Information:

(1) Annual Fixed Cost other than Interest Rs.

28,00,000
(2) Variable Cost Ratio 60%
(3) Total Assets Turnover Ratio 2.5
(4) Tax Rate 30%

You are required to calculate:

(i) Earnings per share (EPS), and
(ii) Combined Leverage. (CA IPCC Nov 2011)
Ans: 11.06, 3.04

Question 14: (i) You are required to calculate the Operating leverage from the
following data:
 Sales Rs.50,000
Variable Costs 60%
Fixed Costs Rs.12,000

(ii) You are required to calculate the Financial Leverage from the following data:
Net Worth Rs.25,00,000
Debt/Equity 3:1
Interest rate 12%
Operating Profit Rs.20,00,000
Ans: 2.50, 1.82

Question 15: Z Limited is considering the installation of a new project costing

Rs.80,00,000. Expected annual sales revenue from the project is Rs.90,00,000 and
its variable costs are 60 percent of sales. Expected annual fixed cost other than
interest is Rs.10,00,000. Corporate tax rate is 30 percent. The company wants to
arrange the funds through issuing 4,00,000 equity shares of Rs.10 each and 12
percent debentures of Rs.40,00,000.
You are required to:
(i) Calculate the operating, financial and combined leverages and Earnings per
Share (EPS).
(ii) Determine the likely level of EBIT, if EPS is (1) Rs.4, (2) Rs.2, (3) Rs.0.
(CA PE II Nov. 2009)
Ans: 1.3846, 1.2264, 1.6974 2765714, 1622857, 480000

Question 16: You are given two financial plans of a company which has two financial
situations. The detailed information are as under:

Installed capacity 10,000 units

Actual production and sales 60% of installed capacity
Selling price per unit Rs.30
Variable cost per unit Rs.20

Fixed cost: Situation 'A' = Rs.20,000

Situation 'B' = Rs.25,000
Capital structure of the company is as follows:

Financial Plans
XV XM
Rs. Rs.
Equity Debt 12,000 35,000
(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. (CA IPCC May 2011)
Ans: 1.50, 1.7143 1.136, 1.031, 1.159, 1.036

Question 17: The Share Capital of X Ltd. is Rs.16,00,000 with shares of face value
of Rs.10. It has a Debt Capital of Rs.5,00,000 at 12% interest rate. The sales of the
firm are 2,50,000 units p.a. at a selling price of Rs.6 p u. and the variable cost p.u. is
 Rs.3. The fixed cost amount to Rs.1,00,000 and the company pays tax @ 50%. If the
sales increases by 20%, calculate:-
(a) Percentage increases in EPS.
(b) Degree of Operating Leverage at the two levels.
Degree of Financial Leverage at the two levels.
Ans: 25.437%, 1.1538,1.125, 1.1016,1.081

Question 18: A company had the following Balance Sheet as on March 31, 2006:

Liabilities and Equity Rs. Assets Rs.

(in Crores) (in Crores)
Equity Share Capital (1 crore shares 10 Fixed Assets (Net) 25
of Rs.10 each) Current Assets 15
Reserves and Surplus 2
15% Debentures 20
Current Liabilities 8
40 40

The additional information given is as under:

Fixed Costs per annum (excluding interest) : Rs.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
(ii) Operating Leverage
(iii) Financial Leverage
(iv) Combined Leverage. (CA PE II Nov. 2006)
Ans: 14.40 1.296 1.125 1.458

Question 19: (a) Compute DFL from the following information:-

EBIT Rs.50,000
8% Debentures Rs.2,50,000
10% Preference Share Capital Rs.1,00,000
Tax rate 35%.

b. Compute DFL if EBIT becomes Rs.1,50,000

Ans: 3.421 1.309

Question 20: P Ltd. has the following balance sheet and income statement
information:

Balance Sheet as on March 31st

Liabilities (Rs.) Assets (Rs.)
Equity capital (Rs.10 per share) 6,00000 Net fixed assets 10,00,000
10% Debt 6,00000 Current asset 9,00,000
Retained earnings 6,00000
Current liabilities 6,00000
19,00,000 19,00,000

Income Statement for the year ending March 31

Sales 3,40,000
Operating expenses (including Rs.60,000 depreciation) 1,20,000
EBIT 2,20,000
Less: Interest 60,000
Earnings before tax 1,60,000
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 percent, what will be the earnings per share at the new sales level?

Ans: 1.273, 1.375, 1.75 1.755, 0.845

Question 21: Coke (India), sells 5,00,000 bottles of soft drinks a year. Each bottle
produced has a variable cost of Rs.2.50 and sells for Rs.4.50. Fixed operating costs
are 5,00,000. The company has current interest charges of Rs.60,000 and preferred
dividends of Rs.24,000. The corporate tax rate is 40%.

(a) Calculate the degree of operating leverage, the degree of financial leverage,
and the degree of total leverage, (b) Do part (a) at the Rs.50,000 bottle sales
level, (c) What generalization can you make comparing (a) to (b) after first
finding the Overall break - even point?
Ans: 2, 1.25, 2.5 1.50, 1.11, 1.66

Question 24: ABC Limited has an average cost of debt at 10 percent and tax rate is
40 percent. The Financial leverage ratio for the company is 0.60. Calculate Return on
Equity (ROE) if its Return on Investment (ROI) is 20%. (CA PCC May 2007)
Ans: 15.60%

Question 25: Consider the following information for Omega Ltd.:

Rs. in Lakhs
EBIT (Earnings before Interest and Tax): 15,750
Earnings before Tax (EBT): 7,000
Fixed Operating costs: 1,575

Required: Calculate percentage change in earnings per share, if sales increase by

5%. (CA PE II Nov 2007)
Ans: 12.375%

Question 26: The capital structure of the Progressive Corporation consists of an

ordinary share capital of Rs.10,000,000 (shares of Rs.100 par value) and
Rs.10,00,000 of 10% debentures. Sales increased by 20% from 1,00,000 units to
1,20,000 units, the selling price is Rs.10 per unit; variable cost amounts to t 6 per unit
and fixed expenses amount to Rs.2,00,000. The income tax rate is assumed to be 50
percent. You are required to calculate the following:
(i) The percentage increase in earnings per share;
(ii) The degree of financial leverage at 1,00,000 units and 1,20,000 units.
(iii) The degree of operating leverage at 1,00,000 units and 1,20,000 units.

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.
Ans: 80%, 2 & 1.55, 2 & 1.71

Question 27: The following summarizes the percentage changes in operating income,
percentage changes in revenues, and betas for four pharmaceutical firms.

Firm Change in revenue Change in operating income Beta

PQR Ltd. 27% 25% 1.00
RST Ltd. 25% 32% 1.15
TUV Ltd. 23% 36% 1.30
WXY Ltd. 21% 40% 1.40

Required:
(i) Calculate the degree of operating leverage for each of these firms. Comment also.
(ii) Use the operating leverage to explain why these firms have different beta.
(CA PE –II Nov. 2004)
Ans: (ii) There is a clear relationship between the degree of operating leverage and
the beta. The greater the degree of operating leverage, the more responsive income
(and presumably stock returns) will be to changes in revenue which are related with
changes in market movements.

Question 28: The following details of RST Limited for the year ended 31st March,
2006 are given below:

Operating leverage 1.4

Combined leverage 2.8
Fixed Cost (Excluding interest) Rs.2.04 lakhs
Sales Rs.30.00 lakhs
12% Debentures of Rs.100 each Rs.21.25 lakhs
Equity Share Capital of Rs.10 each Rs.17.00 lakhs
Income tax rate 30 percent

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? (CA PCC May 2007, Nov 2023)

Question 29: X Ltd. details are as under:

 Sales (@ 100 per unit) Rs.24,00,000
Variable Cost 50%
Fixed Cost Rs.10,00,000

It has borrowed Rs.10,00,000 @ 10% p.a. and its equity share capital is Rs.10,00,000
(Rs.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
If the sales increases by Rs.6,00,000; what will the new EBIT?
Ans: 6, 2, 12, 5%, 5,00,000