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Financial Leverage and Cost Analysis

The document discusses various financial concepts related to leverage, including fixed and variable costs, debt, and the impact of sales changes on earnings before interest and taxes (EBIT). It explains the relationships between different financial ratios, such as return on equity (ROE) and debt-to-equity ratios, and introduces the concept of operating and financial break-even points. Additionally, it highlights the importance of understanding the effects of leverage on profitability and risk in business operations.

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jofew12279
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8 views50 pages

Financial Leverage and Cost Analysis

The document discusses various financial concepts related to leverage, including fixed and variable costs, debt, and the impact of sales changes on earnings before interest and taxes (EBIT). It explains the relationships between different financial ratios, such as return on equity (ROE) and debt-to-equity ratios, and introduces the concept of operating and financial break-even points. Additionally, it highlights the importance of understanding the effects of leverage on profitability and risk in business operations.

Uploaded by

jofew12279
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

1

LEVERAGE

eved
to *vobeverage poved
PAGE No.

DATE

12/67/22
enidae)

0 = 293 dold w

Benefit

↓ 70

Fixed cost
/
€4
I

Risk

By creating Fixed charge

ОР.
Fian

Fixed cost
fixed costeir Le tot
wol)
↓
ESC
Long term Sources of fiance.

P.S.C
I

Debt.
More than 12 months.

Sub php

Variable cost

+
which vary proportionally

Perunit
variable cost

in totality vary.
remain constant.

е
PAGE No.

DATE

Fixed cost

Remain fixed upo a certain


level of activity

In totality constant
↓
per unit varity

29162
Production

ancres fixed

Ido cost
cost decreas
Operating fixed cost

rent
product decre fixed

Sld cost increa.


of

deprecision
Fiancial Fixed cost

Interest on debt
05
Pref dividend.

noitudi

Ratiol

Relationship beth two or


more variables which are
interrelated. prolj
Absolute values are totally
useless.

e.g GP ration

GP÷sales X100
ROJ =
EBIT
X
100

Capital employed
Teacher's Signature:.....

PAGE No.
DATE

Capital employed &

ROE
owned Fund + borrowed fund.

earnings
PAT
PD (ea avaylable to ea. hold ivilNet Worth
X 100
EPS =
e.a. to ea hold

No. of [Link]

PV ratio / contribution ratio

b
X17
1
contri sales
X100

variable cost ratio = variable cost

sales
*100
(P.V ratio & variable cost ratio een't
complementory
to each other).
b

•If PV ratio = 30% of sales


then,

variable cost ratio.


cost ratio = 70% of sales
Sales ib
Income Statement
- variable cost

G
contribution
Fixed cost
EBAT/PBIT (Operating Profit)
Interest (long term
bourrowings)
EBT

Tax

Ear to eq PAT
EBIT Belongs to
4

Govt
bebentures
5
200

998
[Link]
P.S.B

E pref DV

earning avail eq te holder

Dividend
Surplus / retain earning.
40

PACE
PAGE NO.

DATE

11
=
0% A in EBIT
Lor
% A in sales
contri

EB J T

IF DOL = 3 3,
Sales changes 1% &
EBIT changes by
3%.

Change will be
bi directional.

DOF =
%A EBT
%A EBIT
In the absence of
PD

or
EBJT

EBT.
(when one income
statement is given

DEL = 2·5
If EBIT change by
1% then EBJ char
2.5%
5

HB-29
H2.p3
of 200/98 183

ewhneded
PAGE No.

DATE
17

DCL -> In the absense in PD

DCL =
% A in EPS % A in sales
Contri
OF
EBT.
Example
= DCL = 5

the IF sales changes $%


then EPS changes by 5%
(chang will by direction)

83 DCL = DOL X DFL!.

To convert pre tax item


into post tax item
Multiply by (1-t): !!!!!

* To convert Post tax item


intopre tax multi
divided by (1-+)
783

7083 A

* When there is pref


Dividend

DFL = % EBIT
EBTT - Interest - PD

of
J-+

DCL =
contri
EBT.

EBJT - J-
J- PD
EBT
2-t
www
6

PAGE No.

DATE
*

Trading on Equity
↓

use of Debt to increase to


Increase ROE

* Deb is Godd or Bad.


+

In generall

I
Business is Good

Debt is Good

If
ROJ > i
Business is Bad

+
LA

Debt is phetetie
phathetic.
+

JF ROIK i

ROJ By defalf pre tax

ROF J
post tax

In case of unleverved firm


ROE = RO1 (1-+)

* Operating break
even point is that
level of
Sales where EBIT = 0.
EBIT will be = 0
(when contri= fixed
cost)
7
PAGE No.

DATE //
Fiancial break-even point
in that level of EBIT, where
EPS = 0
=

dad

- Fian break even


point (EBJ) = &nt +
pp
book
(1=+)

* combine break even point


in that level of

Sales

EPSO

book Bi

AL BEP

b
A+ BE P

Leverage

will zero undefine.

zero

20000
below BEP

+ve

109
-

ve
(Hint to solve
question)
If fiancial leverage,
amount of interest &
is given we can find
EBAT,
operating lev
contri & Fixed
cost:

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