Page 395 - Corporate Finance PDF Final new link

BRILLIANT’S Leverage Analysis 395

Note: Alternatively combined leverage can be worked out as follows:
Combined leverage = Operating leverage × Financial leverage
P. Ltd. = 2 × 1.5 = 3.0 Q. Ltd. = 2.33 × 1.5 = 3.5
(ii) Comments:
(a) Operating leverage; it is higher in case of Q. Ltd. and hence it has greater degree of
business risk.
(b) Financial leverage; both the companies have the same degree of financial risk.
(c) P. Ltd. has less risk as compared to that of Q. Ltd.
Notes:
(1) Risky Situation: High operating leverage with high financial leverage will constitute
risky situation.
(2) Normal Situation : If one is high another should be low, i.e., if the company has a low
operating leverage, financial leverage can be higher and vice-versa.
(3) Ideal Situation: Both should be low. Low operating leverage combined with low financial
leverage will constitute an ideal situation.

Illustration 4.3.6 NPP
Following figures relate to three companies P, Q, R:
{ZåZ{b{IV Am§H$‹S>o VrZ H§$nZrO P, Q, R go g§~§{YV h¢…

Particulars P Ltd. Q Ltd. R Ltd.
({ddaU) (P {b{‘Q>oS>) (Q {b{‘Q>oS>) (R {b{‘Q>oS>)

Output (Units) / AmCQ>nwQ> (BH$mB¶m§) 3,00,000 75,000 5,00,000
Fixed Operating Cost / {’$³ñS> Am°naoqQ>J H$m°ñQ> ` 3,50,000 ` 7,00,000 ` 75,000
Unit Variable Costs / ¶y{ZQ> do[aE~b H$m°ñQ> ` 1 ` 7.50 ` 0.10

Interest Expenses / B§Q>aoñQ> E³gn|gog ` 25,000 ` 40,000 Nil
Unit Selling Price / ¶y{ZQ> goqbJ àmBg ` 3 ` 25 ` 0.50

You are required to calculate for all the 3 companies:/ AmnH$mo g^r VrZ H§$nZrO Ho$ {bE JUZm H$aZm h¡…
(a) DOL (b) DFL (c) DCL
Solution:

Particulars P Ltd. Q Ltd. R Ltd.

Total output (sales) 9,00,000 18,75,000 2,50,000
Less: Variable costs 3,00,000 5,62,500 50,000
Contribution 6,00,000 13,12,500 2,00,000
Less: Fixed costs 3,50,000 7,00,000 75,000