Transcript Operating leverage

An increased means of accomplishing some purpose
Ex: lifting of heavy objects with the help of leverage.
TYPES OF LEVERAGE
 FINANCIAL LEVERAGE:
 It arises out of fixed financial charges
 OPERATING LEVERAGE:
 It arises out of fixed operating costs
Financial Leverage
The amount of debt used to finance a firm's
assets. A firm with significantly more debt
than equity is considered to be highly
leveraged.
MEASURE OF FINANCIAL LEVERAGE
 The use of long term fixed interest bearing debt and
preference share capital along with equity share capital
is called financial leverage
 Degree of financial leverage =
 EBIT / EBIT-I
 EBIT = Earnings before Interest and Taxes
 I= Interest
 Degree of Financial Leverage =
 % changes in EPS / % change in EBIT
Operating leverage:
 The operating leverage has got a bearing on fixed
costs. If the firm employs more of fixed costs in its
production process greater will be
the operating leverage fixed costs
 Operating leverage = contribution/operating profit
 Ex: sales 5000unists @rs 6 per unit variable expenses
Rs2 per unit fixed expenses 10000
 When fixed costs are lower the operating leverage
shows a lesser and will have more EBIT
Combined Leverage:
 Financial Leverage exists with the use of debt funds,
and it is determined by the mix of debt and equity
funds operating leverage arises from the use of fixed
costs and it is determined by the firms cost structure
use of debt involves payments of interest, and fixed
cost
 Combined leverage = OL X FL
 = contribution/EBIT
X
EBIT/EBIT-I

Contribution /EBIT- I
 Degree of combined leverage = DOL X DFL
 (%change in EBIT / %change in Sales) X (%change
in EPS / %Change in EBIT)
 A company has sales of 500000 variable costs 300000
fixed costs 100000 and long-term loans of 400000 at
10% rate of interest calculate the composite leverage
 Sales 2000000 variable cost 1400000 amd fixed cost
400000 and debt of 1000000 at 10% rate of interest
find out combined leverage if the firm wants to double
its EBIT how much of a rise in sale needed on
percentage basis
 Calculate the percentage of change in EPS if sales are
increased by 5%
EBIT 1120 (Lakhs) EBT 320 Fixed cost 700
 Sales revenue
1000000
 Variable cost
600000
 Fixed cost
250000
 Calculate degree of operating leverage
1250000
750000
250000
 Percentage change in EBIT/ Percentage change in sales

 P company calculate operating and financial
leverages. The company’s current sales revenue is
1500000 lakhs and sales are expected to increase by
25% 900000 incurred on variable expenses for
generating 15lakhs sales revenue the fixed cost is
250000. The company has 20 lakhs equity share
capital share capital and 20 lakhs 10% debt capital
Rs 10 per equity share and 50% tax rate
Ex:
 A firm is considering tw0 financial plans with a view to
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examining their impact on EPS total funds required
5,00,000
Financial plan
10%Debt
4,00,000
1,00,ooo
Equity 10Rs each
1,00,000
4,00,000
The earnings before interest and tax are
assumed50,000 , 75000, 125000 tax 50%
Ex:
 A Limited company has equity share capital of 500000
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
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divided into shares of 100 each it wishes to raise
further 300000 for expansion The company plan are
1)All common stock
2)100000 inequity and 200000 in 10% debentures
3) all debt 10%
4)100000 equity and 200000 in 8% preference shares
The company earnings before interest and tax are
150000 tax rate 50%
You are required to determine earnings per share in
each plan