Financial and Operation Leverage

8/2/2019 Financial and Operation Leverage

1/19

Financial And Operation

Leverage

By Group -7

D.V. R.K. Raju (1225111311)

Pratyusha .L (1225111328)Priyanka Pradip(1225111339)

Rajesh .T (1225111343)

Anusha.S(1225111347)


2/19

Concept of Leverages Operating leverages DOL

Operating risk Financial leverages DFL Financial Risk

Combines Leverages

Out line


3/19

Leverage is very scientific tool in the hand of finance

manager .

Financial structure is just mix of debt and equity and

with help of leverage. Main aim of leverage testing is maximize the earning of

shareholder and reduce the risk of company.

Type of leverage :-Operation

Financial

Combined

Concept


4/19

Leverage and The income statement

Sales- Fixed costs- Variable costs

EBIT- Interest

EBT- Taxes

EAT

Operating Leverage

Financial Leverage

TotalLeverage


5/19

It is caused due to fixed operating expenses in a firm. Tells the EBIT will greater than sale because due to

increasing sale of fixed cost per unit will decrease

and it will increase EBIT higher than sale .

Operating

Operating Leverage = % change in EBIT

% change in Sale


6/19

Example

(Q) A firm sells products for 100 /unit, has variable operating cost ofRs 50/unit and fixed operating cost of Rs 50,000/yr. Show the various

levels of EBTI that would result from sales of 1000units, 2000units,

3000units.

Solution: The sales level of 200 units used as a base for comparison.

Case-2 base case-1

(-50%) (+50%)

Sales in units 1000 units 2000 units 3000 units

sales revenue 100,000.00 200,000.00 300,000.00(-)Variable operatingcost 50,000.00 100,000.00 150,000.00

contribution 50,000.00 100,000.00 150,000.00

(-)Fixed operating cost 50,000.00 50,000.00 50,000.00

EBIT - 50,000.00 100,000.00


7/19

Key to Symbols Used

Note: The symbols used in the notes differsomewhat from the symbols used in the text.

P = price per unit Q = sales in units V = variable cost per unit F = fixed costs

VC = total variable costs TC = F + VC = total costs S = PQ = sales dollars EBIT = S - TC


8/19

Dol measures quantitative terms .

Degree of operating leverage (dol)

EBIT

VCS

FVCS

VCS

FVPQ

VPQ

DOL

=

)(

)(=

Salesin%

EBITin%


9/19

Sales (100000 units@ 8) 800,000

(-) Variable cost (100000@ Rs 4) 400,000

Contribution 400,000

(-)Fixed costs 280,000

EBIT 120,000

Example

33.3000,280)48(000,100

)48(000,100

RsRsRs

RsRsDOL

DOL = 3.33


10/19

Risk of not able to cover fixed operating cost by firm.

The larger the magnitude, the larger the volume ofsales required to cover all fixed cost.

Operating risk


11/19

Caused due to the fixed financial costs (interest) infirm.

Defined as the ability of a firm to use fixed financialcharges to magnify the effects of changes in EBIT on theearnings per share.

Financial leverages

N

TINTEBIT

N

PAT

EPS

)1)((


12/19

Where T is the corporate tax rate and N is thenumber of ordinary shares outstanding. If the firmdoes not employ any debt, then the formula is

Measures of financial leverage

Debt ratio

Debt equity ratio

Interest coverage

N

T)-(1EBIT

EPS

ED

DL

E

DL

Interest

EBITL


13/19

Case-2 Base Case -1

-40% 40%

EBIT 30000 50000 70000

(-)Interest 10000 10000 10000EBT 20000 40000 60000

(-) Taxes 7000 14000 21000

EAT 13000 26000 39000

EPS 2.6 5.2 7.8

-50% 50%

Example

A company has Rs 100000, 10% debentures and 5000equity shares outstanding. It is in the 35 %tax bracket.Assuming three levels of EBIT (i) Rs 50,000, (ii) Rs 30,000,and (iii) Rs 70,000 calculate the change in EPS. (base levelof EBIT = Rs 50,000).


14/19

Financial leverage can be more precisely expressedin terms of the DFL.

Degree of financial leverage

DFL %

%

in EPS

in EBIT

=EBIT

EBIT - I


15/19

Example

25.140%

50%1

Case

25.140%-

50%-2 Case

25.1

10,000Rs-50,000Rs

50,000Rs

DFL =1.25


16/19

The risk of not being able to cover fixed financialcosts by a firm.

Degree of variability of EBIT, the variability of EPS

increase with more financial leverages.

Financial risk can be avoidable risk if the firm decides not touse any debt in its capital structure

Financial Risk


17/19

Product of Operating leverage and Financialleverage

DCL = DOL x DFL

Combined leverage

salesinchange

EPSinchangeDCL

%

%

IEBIT

VCSDCL


18/19

DCL = DOL x DFL

DOL = 3.33

DFL = 1.25

DCL= 4.1625

Total risk: Is the risk associated with combined leverage

Example


19/19

Documents

Financial and Operation Leverage