financial and operation leverage
TRANSCRIPT
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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)
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Concept of Leverages Operating leverages DOL
Operating risk Financial leverages DFL Financial Risk
Combines Leverages
Out line
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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
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Leverage and The income statement
Sales- Fixed costs- Variable costs
EBIT- Interest
EBT- Taxes
EAT
Operating Leverage
Financial Leverage
TotalLeverage
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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
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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
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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
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Dol measures quantitative terms .
Degree of operating leverage (dol)
EBIT
VCS
FVCS
VCS
FVPQ
VPQ
DOL
=
)(
)(=
Salesin%
EBITin%
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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
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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
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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)((
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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
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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).
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Financial leverage can be more precisely expressedin terms of the DFL.
Degree of financial leverage
DFL %
%
in EPS
in EBIT
=EBIT
EBIT - I
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Example
25.140%
50%1
Case
25.140%-
50%-2 Case
25.1
10,000Rs-50,000Rs
50,000Rs
DFL =1.25
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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
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Product of Operating leverage and Financialleverage
DCL = DOL x DFL
Combined leverage
salesinchange
EPSinchangeDCL
%
%
IEBIT
VCSDCL
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DCL = DOL x DFL
DOL = 3.33
DFL = 1.25
DCL= 4.1625
Total risk: Is the risk associated with combined leverage
Example
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