Module - I

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LEVERAGES AND & : 99035
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CAPITAL STRUCTURE THEORIES
Leverage and Capital Structure Theories

1) A firm has sales of Rs. 5,00,000 variable cost of Rs. 3,50,000 and fixed cost of Rs. 1,00,000 and
debt of Rs. 2,50,000 at 10% rate of interest. What is combined leverage? If the firm wants to
double its EBIT, how much of a rise in sales would be needed on a percentage basis?
[Ans. Combined Leverage-6, 33.33%.]

2) From the following information of Trends Ltd. calculate the degree of operating leverage, financial
leverage and combined leverage for each situations A and B under financial plans 1,2and 3. Also
indicate which of the above plans is most and which one is least risky:

Production price and sales 1,000 units

Selling price per unit Rs. 20
Variable cost per unit Fixed Rs. 15
cost (operating) Situation –
A Rs. 3,000
Situation – B Rs.4000

Capital structure:

Plan – A Plan – B Plan - C

Equity 7,000 5,000 3,000
10% Debt 3,000 5,000 7,000
Total 10,000 10,000 10,000

3) From the following information, compute sales: DOI-2,DFL-3, interest Rs. 3,00,000 and
contribution is 40% of sales.
[Ans.Sales-22,50,000]

4) Relevant information about three companies are given below:

BIL PIL MIL
Annual Production Capacity (units) 1,00,000 1,50,000 2,50,000
Capacity Utilisation and sales 75% 75% 75%
Unit selling price (Rs.) 40 50 50
Unit Variable cost (Rs.) 15 15 20
Fixed cost p.a.(Rs.) 2,00,000 3,00,000 5,00,000
Equity capital (Rs.) 5,00,000 7,00,000 10,00,000
(10,000 shares for each company)
10% Preference capital (Rs.) 50,000 1,00,000
15% Debenture (Rs.) 1,00,000 2,00,000 3,00,000
Calculate operating leverage, financial leverage, combined leverage and EPS of these three
companies and comment.
[Ans:
Bil Pil Mil
ESP= earnings foe Eq. Holders/no. of 830 1,798.75 2,530
shares

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DOL = contribution/EBIT 1.12 1.08 1.10
DLF = EBIT / EBT 1.009 1.008 1.009
DCL = DOL*DLF 1.13008 1.08864 1.1099
Company Mil has highest EPS (Rs. 2,530) and comparatively moderate level of leverage
(1.1099)hence it can be said that the overall position of company Mil is good.

5) The following information has been taken from the income statement of X Ltd.
Fixed operating expenses Rs.1,200
Fixed financial charges Rs. 600
Earnings before tax Rs. 400 Calculate
% of change in EPS, if sales increases by 10%.
[Ans.% change in EPS= 5.5, % change in sales = 55%]

6) A multiproduct company has the following costs and output data for the year 2008-2009.
Products X Y Z
Sales Mix 40% 35% 25%
Unit Selling Price 20 25 30
Variable Cost p.u 10 15 18
Fixed Cost (Rs): 1,50,000
Sales (Rs): 5,00,000
Find out the breakeven point of sales.
[Ans.Rs. 3,40,909]

7) The capital structure of Moon Ltd. is given below:

Rs.
(Lakhs)
Equity share capital (Rs. 10 each per share) 10.00
Retained earnings 6.00
10% preference share capital 4.00
-
20.00

The firm has planned to undertake an expansion scheme of Rs. 10,00,000 which can be financed
(a)entirely by issue of equity shares of Rs. 10 each; (b) by issue of 12% debentures of . 100 each at
par. As a result of expansion, sales and operating fixed cost will increase by 60% and 75%
respectively. The other relevant information are given below:
Sales Rs. 50,00,000
Variable cost 60%
Operating fixed cost 5,00,000
Corporate tax 40%

Calculate leverages and EPS before and after expansion and give your opinion for taking appropriate decision
with respect to financing.
[Ans.: Before Expansion: DOL-1.33, DFL-1.00, DCL-1.33, AE Option I: DOL-1.38, DFL-1.00,
DCL-1.38, AE Option II: DOL-1.38, DFL-1.05, DCL-1.45]
.
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8) Which of the following financial plans would you recommend and why?
Particulars Equity plan Equity preference Equity debt
share plan plan

Earnings per share EPS Price Rs. 9.50 Rs. 8.00 Rs. 11.25
earnings ratio (P/E) 20 17 16

[Ans. Equity Plan may recommend as its Price Earnings Ratio and Market Price per Share is
Highest with an optimum EPS.]

9) Malancha Plast Ltd. provides you the following information:

Capital Gearing Ratio 3
Fixed Cost : 1/3rd of the total operating cost
Dividend yield 6%
Operating Ratio 75%
Ratio of 18% preference Shares to 15% debentures 12.5%
Dividend Payment Ratio 30%
Accumulated Reserves 4,00,000
Capital Employed 24,00,000
Market Price of an Equity Share of Rs.10 135
Tax rate: 40%

Prepare an Income Statement and calculate the degree of operating leverage, financial leverage and
combined leverage.
[Ans. DOL= 2,DFL = 1.25, DCL = 2.50]

10) Given the following information:

Sales (10,000 units) Rs. 10,00,000
Variable cost per unit Rs. 60
Interest Rs. 1,00,000
EBT Rs.2,00,000
DCL 2.5
Calculate Operating Leverage and Financial Leverage.
[Ans. DOL = 1.33, DFL = 1.50, DCL = 2.00]

11) A simplified income statement of Fortune Ltd. is given below:

Sales Rs. 12,00,00
Variable cost Rs. 9,00,000
Fixed cost Rs. 1,00,000
EBIT Rs. 2,00,000
Interest Rs. 70,000
Tax (30%) Rs. 39,000
Net Income Rs. 91,000
Calculate the following:
ĂͿ Degree of operating Leverage
ďͿ Degree of financial leverage
ĐͿ Degree of combined leverage

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[Ans. DOL = 1.50, DFL = 1.54, DCL = 2.31.]
12) If the combined leverage and operating leverage of a company are 2.5 and 1.25 respectively, find
the financial leverage and P/V ratio, given that the equity dividend per share is Rs. 2, interest
payable per year is Rs. 2 lakhs,total fixed cost Rs. 1 lakh and sales Rs. 20 lakh.
[Ans. Financial leverage – 2,P/V ratio – 25%]

13) Zica Ltd. provides you the following information:

Capital structure; 12% debenture Rs. 2,00,000; 9% preference Share Capital Rs. 3,00,000 and
4,000 equity share of Rs. 100 each.
Revenue operating cost details : sales 3,000 units @ Rs. 600 p.u.; Variable operating cost p.u. Rs.350;
Fixed operating cost Rs. 3,20,000.
Corporate Income tax rate and Dividend Distribution Tax rate may be assumed at 30% and 10%
respectively.
Calculate DOL, DFL and DCL of Zica Ltd. using the concept of leverage, find the percentage change
in EPS when sales increases by 10%.
[Ans. DOL = 1.74 , DFL = 1.06 , DCL = 1.84 , % change in EPS = 18.4%]

14) The degree of operating leverage at a specific level of operation of a firm is 2.50.if the sales
increases by 4% then how much will be the % change in EBIT.
[Ans. 10%]

15) If degree of operating leverage is 2.5 and degree of financial leverage is 1.2, then calculate the
degree of total leverage.
[Ans. 3 .]

16) If the DOL is increased by 50% and the DFL is decreased by 20%, then what will be the impact on
DTL?
[Ans. 20%.]

17) If, a specific level of operations, the percentage change in EPS that may occur if the EBIT changes,
is thrice the percentage change in EBIT, and the percentage change in EPS that may occur if the
sales changes,is six times the percentage change in sales, then calculate the percentage change in
EBIT that may occur for a 1 per cent change in sales.
[Ans. 2%.]

18) Consider the following information –

Quantity produced 1000 units Interest Rs. 2 crores
Variable cost per unit Rs.4,75,000 Preference dividend Nil
Selling price per unit Rs. 6,00,000 Tax rate 30%
Fixed cost Rs. 5 crores
Calculate the financial breakeven point.
[Ans. 400 units.]

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19) Consider the following information –

Quantity produced 1000 units
Variable cost per unit Rs.4,75,000
Selling price per unit Rs. 6,00,000
Fixed cost Rs. 5 crores
Calculate the operating breakeven point.
[Ans.400 units.]

20) A company has an operation leverage of 1.2 as against 1.25 during the previous year. If the current
fixed cost is 25% more than that of the previous year, to what extent has the contribution earned
by the firm changed over the previous year?
[Ans.50%]

21) The followings details of A Ltd. for the year ended 31.03.2005 are furnished:
Operating Leverage 3:1
Financial leverage 2:1
Interest charges per annum Rs.20 lakhs
Corporate tax rate 50%
Variable cost as a %of sales 60%
repare the income statement of the company.
[Ans. PAT 10]

22) If the combined leverage and operating leverage figures of a company are 2.5 and 1.5 respectively,
find the financial leverage, and P/V ratio, given that the equity dividend per share is Rs. 2, interest
payable per year is Rs. 1 lakhs, total fixed cost Rs. 0.5 lakh and sales Rs. 10 lakhs.
[Ans.- 25%.]

23) XYZ. Ltd. had the following Balance Sheet for the year ended 31st December 2004.
Liabilities RS. In lakhs Assets Rs. In lakhs
Equity capital (1 lakh share of Rs. 1 10 Fixed Assets (net) 25
each)
Reserves and Surplus 2 Current Assets 15
15% Debentures 20
Current Liabilities 8

Additional informations:
Fixed cost per anum (excluding interest) RS. 8 lakhs
Variable operating cost ratio 80%
Total Assets Turnover ratio 3
Income tax 50%
Required: 1) earnings per share 2)operating Leverage 3) financial Leverage 4) combined
Leverage 5) current Ratio.
[Ans. 1) 6.50 per share, 2) 1.50, 3) 1.23, 4) 1.85, 5) 1.875.]

24) A firm has sales of ₹10,00,000, variable cost of ₹7,00,000 and fixed cost of ₹2,00,000. The
company has debt capital of 23.00.000 at 10% rate of interest. Compute operating. financial and
combined leverages. If the firm wants to double its earnings before interest and tax (EBIT),

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how much rise in sales would be required?
[Ans. 33.33%]

25) The following details of P Ltd. for the year ended 31.3.2016 are furnished :
Operating leverage 3:1
Financial leverage 2:1
Interest charges per annum 20 lakhs Corporate
tax rate 50%
Variable cost as the percentage sales 60% Prepare
the income statement of the company.
[Ans. PAT=10,00,000]

26) Calculate different kinds of leverage from the following information of XYZ Company:
Production and Sales 16,000 units

Selling price per unit Rs 30

Variable cost per unit Rs 20

Fixed Operating Costs:

Situation A Rs 4,000

Situation B Rs 2,000

Situation C Rs 6,000

Plan
Financial alternatives: I II III

Equity Rs 15,000 Rs 10,000 Rs 5,000

Debt Carrying 10% interest Rs 5,000 Rs 10,000 Rs 15,000

27) Relevant information about two companies are given below:

X Y
Annual production capacity (Units) 1,00,000 1,50,000

Capacity utilisation and sales 75% 75%

Unit selling price (Rs) 40 50

Unit variable cost (Rs) 15 15

Fixed cost for the year (Rs) 2,00,000 3,00,000

Equity capital (Rs 10 per share) 5,00,000 7,00,000

10% Preference share capital (Rs) 50,000

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15% Debentures (Rs) 1,00,000 2,00,000

Determine the degree of Operating Leverage, degree of Financial Leverage, degree of Combined Leverage
and Earning per Share of two companies. (Tax rate 40%)

28) The selected financial data for two companies namely X and Y for the year ended March 2019
are as follows:
;ĂͿ Prepare income statements for X and Y
;ďͿ Comment on the financial position of the companies

Particulars X Y
Variable expenses as a percentage of sales 75 50

Interest (in lakhs) 300 1000

Degree of operating leverage 6 2

Degree of financial leverage 4 2

Income tax rate 0.35 0.35

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