What is financial leverage and how can it be applied practically?

If the fixed costs are higher, the firm’s operating leverage and its operating risks are higher. If operating leverage is high, it means that the break-even point would also be reached for a very marginal drop in sales. The variable costs are 40% of the sales while the fixed operating costs amount to ₹ 30,000. The amount of interest on long-term debts is ₹ 10,000.

Under Traditional Approach, overall cost of capital remains same. Under NI Approach, overall cost of capital remains same. Under NOI Approach, overall cost of capital remains same.

All earnings are paid out as Dividends at year end. Both the companies earn 20% Before Interest and Taxes on their Total Assets of Rs 30 lakhs. If Fixed cost rises DOL rises and EPS falls. Therefore fixed cost if preferable on lower side. Calculate the Percentage of change in earnings per share, if sales increased by 5%. Calculate the Percentage of change in earnings per share if sales increased by 5%.

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Financial leverage is the second aspect of leverage other than operating leverage. When we refer to financial leverage we are referring to the inclusion of debt in the capital structure of a company. Why is inclusion financial leverage is zero if of debt so important? Firstly, debt has a cost that is lower than the cost of equity. Thus inclusion of debt reduces your overall cost of capital and therefore makes your capital structure more optimal.

If EBIT rises by 1% at the firm, then EPS will rise by 3.5%. If EBIT rises by 3.5% at the firm, then EPS will rise by 1%. If sales rise by 3.5% at the firm, then EBIT will rise by 1%. Greater the size of the business unit larger will be the https://1investing.in/ requirement of working capital. The number of gross assets is equal to net capital employed. Students should practice Leverages – CS Executive Financial and Strategic Management MCQ Questions with Answers based on the latest syllabus.

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Concept of operating leverage applied. Combined leverage is 4, this means that 1% change in sales will cause 4% change in PAT/EPS. QPR Ltd. has high business risk & financial risk as compared to ABC Ltd. Combined leverage is 4, this means that a 1% change in sales will cause 496 change in PAT/EPS. Thus, 5% changes in sales will cause a 20% change in PAT/EPS. Degree of___is the ratio of percentage change in gaming per share to the percentage change in sales.

The tendency of profit after tax to vary disproportionately with the fixed cost. This is to inform that, many instances were reported by general public where fraudsters are cheating general public by misusing our brand name Motilal Oswal. Though we have filed complaint with police for the safety of your money we request you to not fall prey to such fraudsters. You can check about our products and services by visiting our website You can also write to us at , to know more about products and services. In fact, if banks write off these loans it may actually impel companies to continue to borrow recklessly and create moral hazard.

Compute the operating leverage for the three situations. The capital structure of a company consists of the following securities. The tendency of sales to vary disproportionately with the fixed cost.

It has two alternatives in financing the project cost. If Sales rises DOL reduces and EPS increase. Therefore sales is preferable on higher side. Calculate the Operating Leverage of the Company given that combined leverage is 3. The amount of earnings per each outstanding share of a company’s stock. Leverage is a financial tactic to multiply gains and losses, accomplished through borrowing capital on existing assets.

Using the concept of combined leverage, State by what percentage taxable income will increase if sales increase by 6%. D Ltd. has high operating leverage and hence its business risk is higher as compared to other companies. High operating leverage shows a higher burden of fixed cost. With the increase in fixed cost operating leverage diminishes.

• High combined leverage shows the combined effect of a higher burden of fixed and interest cost consequently higher business & financial risk.
• The tendency of profit after tax to vary disproportionately with the fixed cost.
• The amount of earnings per each outstanding share of a company’s stock.

QPR Ltd. is identical to ABC Ltd. except in respect of the pattern of financing. The latter finances its assets 50% by equity and 50% by debt, the interest on which amounts to ₹ 20,000. The capital structure of the company consists of equity shares and preference shares. If a business firm has a lot of fixed costs as compared to variable costs, then the firm is said to have high operating leverage.

Leverages – Financial and Strategic Management MCQ

A firm can finance its investments through debt and equity.In addition, companies may also use preference capital. The rate of interest on debt is fixed.Similarly the rate of dividend on preference shares is fixed, though preference dividend is paid from profit after tax. Total assets of Q Ltd. are ₹ 6,00,000. The total assets turnover ratio is 2.5 times. The fixed operating costs are ₹ 2,00,000 and the variable operating cost ratio is 40%. Determine the likely level of EBIT if EPS is ₹ 6.

Sales to Variable Cost ratio is 150% and Fixed Cost other than interest is Rs. 5,00,000 p. Company has 11% debentures of Rs. 30,00,000. Use of funds with a contribution cost in order to increase earnings before interest and taxes. Use of funds with a product cost in order to increase earnings per share. Of shares9,0009,0009,000EPS120Perform reverse working downward to upward. If there is a 10% increase in sale, EBIT increase by 35% (10 × 3.5).

Rs. 15 lakhs in equity shares of Rs. 100 each and the balance through preference shares with 12% dividend. From a financial point of view, financial leverage is calculated as total debt /shareholder equity. Calculate the degree of financial leverage for a firm when its EBIT is ₹ 20,00,000.

Operating & financial leverage both should be high. The tendency of profit before tax to vary disproportionately with operating profit . The Highly risky situation as it consists of large interest costs. ___ is the ratio of net operating income before fixed charges to net operating income after fixed charges. The higher growth shown in profits due to leverage is more due to the lower base effect.

What is financial leverage and how can it be applied practically?

After expansion, sales will increase by 25% and fixed cost by ₹ 3,00,000. ABC Ltd. has an average selling price of ₹ 10 per unit. Its variable unit costs are ₹ 7 and fixed costs amount to ₹ 1,70,000. It finances all its assets with equity funds.

LEVERAGE

Operating leverage is directly__ to business risk. In the above example, the company has zero debt in the first year but takes on debt in the second year. As a result of the debt, the company incurs an interest cost in the second year. To understand DFL, let us look at a scenario where EBIT moves up by 20% as under.. Shubham Ltd. retains Rs 7,50,000 out of its Current Earnings.