Answer to Question #230592 in Accounting for rashmi agarwal

Question

The capital structure of ABC Pvt. Ltd is as follows:

Equity share capital (eachshareofRs.10) = Rs.16, 00,000

Debentures with a coupon rate of 10% = Rs. 10, 00,000

Reserves and surplus = Rs.15, 00,000

Revenue from the business activities for the company is Rs. 2.00 crores. Its variable cost is 10% of the revenue, fixed operating cost is Rs. 60 lakhs and the company pays income tax at a rate of 25%. (10Marks)

a. Calculate financial leverage, operating leverage and combined leverage for the company.

b. Determine the likely level of EBIT for EPS of (i) Rs.45, (ii) Rs.60, and(iii) Rs. 75.

Answer 1

Solution:

a.). Financial Leverage =$\frac{Total \; Debt}{Shareholders\; Equity}$

Total Debt = 1000,000

Shareholders Equity = Equity shares + Reserves and Surplus = 1,600,000 + 1,500,000 = 3,100,000

Financial Leverage = $\frac{1,000,000}{3,100,000} = 0.32$

Financial Leverage = 0.32

 

Operating Leverage = $\frac{Fixed \; Costs}{Total\; Costs}$

Fixed Costs = 60 lakhs = 0.60 crores

Variable Costs = $10\%\times 2$ crores = 0.20 crores

Total Costs = FC + VC = 0.60 + 0.20 = 0.80 crores

Operating Leverage = $\frac{0.60}{0.80} = 0.75$

Operating Leverage = 0.75

 

Combined Leverage = Operating Leverage x Financial Leverage = 0.75 $\times$ 0.32 = 0.24

 

Combined Leverage = 0.24

b.). EBIT for EPS of:

i.). Rs.45

EPS = $\frac{Net \; Income}{No\;of \;Shares\;Outstanding}$

No. of shares outstanding = $\frac{1,600,000}{10}$ = 160,000 shares

45 = $\frac{Net \; Income}{160,000}$

Net income = 45 x 160,000                = 7,200,000

Less Income Tax (25$\% \times$ 7,200,000) = (1,800,000)

Less Interest (10$\% \times$1,000,000)       =   (100,000)

EBIT                                                   = 5,300,000

 

ii.). Rs.60

60 = $\frac{Net \; Income}{160,000}$

Net income = 60 $\times$ 160,000                = 9,600,000

Less Income Tax ($25\% \times$7,200,000) = (2,400,000)

Less Interest ($10\% \times$ 1,000,000)       =   (100,000)

EBIT                                                   = 7,100,000

 

ii.). Rs.75

75 = $\frac{Net \; Income}{160,000}$

Net income = 75 $\times$160,000          = 12,000,000

Less Income Tax ($25\% \times$ 25% x 7,200,000) = (3,000,000)

Less Interest (10$\% \times$ 1,000,000)        =   (100,000)

EBIT                                                   = 8,900,000