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) OPERATING LEVERAGE. (B) FINANCIAL LEVERAGE. (C) COMBINED LEVERAGE. (D) IF THE FIRM WANTS TO DOUBLE ITS EBIT, HOW MUCH OF A RAISE IN SALES WOULD BE NEEDED ON A % BASIS ? Sol :- INCOME STATEMENT PARTICULARS AMOUNT RS. SALES 10,00,000 LESS : VARIABLE COST ( 70% OF 10,00,000 ) 7,00,000 CONTRIBUTION 3,00,000 LESS : FIXED COST ( TOTAL COST – VARIABLE COST i.e 9,00,000 - 7,00,000 ) 2,00,000 EBIT 1,00,000
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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) OPERATING LEVERAGE.(B) FINANCIAL LEVERAGE.(C) COMBINED LEVERAGE.(D) IF THE FIRM WANTS TO DOUBLE ITS EBIT, HOW MUCH OF A RAISE
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)
SALES { 3 = SALES/ 300 } 900
LESS : VARIABLE COST ( 50% OF 900 )
450
CONTRIBUTION 450LESS : FIXED COST ( 1/6TH OF 900 )
150
EBIT 300LESS : INTEREST ( 10% OF 120 )
12
NPBT 288LESS : TAX @ 35% 100.8
NPAT 187.2
NO. OF EQUITY SHARES 9
EPS 20.8 Times
P/E 2.5 Times
MARKET PRICE 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 YEAR’S 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) THE AFTER-TAX RATE OF RETURN ON ASSET,(II) THE EARNINGS PER SHARE (III) THE RATE OF RETURN ON SHAREHOLDERS EQUITY FOR EACH
OF THE THREE FINANCING ALTERNATIVES. ALSO SUGGEST WHICH ALTERNATIVE SHOULS BE ACCEPTED BY THE FIRM.