Question #230592

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.


1
Expert's answer
2021-08-30T14:32:59-0400

Solution:

a.). Financial Leverage =Total  DebtShareholders  Equity\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 = 1,000,0003,100,000=0.32\frac{1,000,000}{3,100,000} = 0.32


Financial Leverage = 0.32

 

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


Fixed Costs = 60 lakhs = 0.60 crores

Variable Costs = 10%×210\%\times 2 crores = 0.20 crores

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


Operating Leverage = 0.600.80=0.75\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 = Net  IncomeNo  of  Shares  Outstanding\frac{Net \; Income}{No\;of \;Shares\;Outstanding}


No. of shares outstanding = 1,600,00010\frac{1,600,000}{10} = 160,000 shares


45 = Net  Income160,000\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%×\% \times1,000,000)       =   (100,000)

EBIT                                                   = 5,300,000

 

ii.). Rs.60

60 = Net  Income160,000\frac{Net \; Income}{160,000}

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

Less Income Tax (25%×25\% \times7,200,000) = (2,400,000)

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

EBIT                                                   = 7,100,000

 

ii.). Rs.75

75 = Net  Income160,000\frac{Net \; Income}{160,000}

Net income = 75 ×\times160,000          = 12,000,000

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

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

EBIT                                                   = 8,900,000

 


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