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386 Corporate Finance BRILLIANT’S

Q.43. How is operating leverage different from financial leverage?
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OR
Differentiate between operating and financial leverage.
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Difference between Operating Leverage & Financial Leverage
Basis Operating Leverage Financial Leverage
1. Meaning Operating leverage may be defined as Financial leverage may be defined as
the firm's ability to use fixed the firm's ability to use fixed financial
operating costs to magnify the effect charges to magnify the effects of
of changes in sales on its earning changes in EBIT on the firm's EPS.
before interest and taxes (EBIT).
2. Factors used Operating leverage is dependent on Financial leverage is dependent on
three factors: following factors:
(a) Sale volume; (a) Sale volume;
(b) Fixed cost (in monetary terms); (b) Fixed cost;
and (c) Variable cost; and
(c) Variable cost. (d) Interest.
Contribution EBIT
3. Formulae 1. = O.L 1. = F.L.
EBIT EBT
% change in EBIT % change in EPS
2. = DOL 2. = DFL
% change in Sales % change in EBIT
4. Indication The degree of operating leverage gives The degree of financial leverage gives
an indication regarding the extent to an indication regarding the extent to
which EBIT may be affected due to which EPS may be affected due to
every change in sales. every change in EBIT.
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