Question

If the combined leverage and operating leverage figures of a company are 2.5 and 1.25
respectively, find the financial leverage and P/N ratio, given that the equity dividend
per share is Rs.2, interest payable per year is 1 lakh, total fixed cost Rs.0.5 lakh and sales
10 lakhs.​

Answer 1

Answer:

fl = 2.00 and pv ratio = 25%

Answer 2

Answer:

Financial leverage = 2

P/V ratio = 25%

Explanation:

Operating leverage refers to a company's business risk while financial leverage relates to a company's financial risk. But what matters to a company is its 'total risk'. The total risk of a company is captured by the 'combined leverage' of the company. Therefore, combined leverage is a measure of a company's total risk. Operating leverage shows the effect of changes in sales revenue on EBIT and financial leverage shows the effect of changes in EBIT on EPS.

Therefore, a company with both operating leverage and financial leverage needs to look at the impact of the change in sales revenue on its EPS. Combined leverage reflects the effect of changes in sales revenue on a company's EPS. Combined leverage is calculated as the product of operating leverage and financial leverage.

Combined leverage = Operating leverage * financial leverage

As per formula; we substitute the value to determine the value of financial leverage

2.5 = 1.25* Financial leverage

$\frac{2.5}{1.25} = Financial leverage$

Financial leverage = 2

For calculating P/V ratio;

firstly we need to determine the value of Contribution

As Financial leverage = $\frac{EBIT}{EBIT-Interest}$

We substitute the value in formula

2 = $\frac{x}{x-100000}$ (Here, we consider EBIT be X)

2 (x-100000) = X

2X - 200000 = X

2X - X = 200000

X = 2,00,000

Here EBIT = Rs. 200000

Now,

Operating Leverage = $\frac{Contribution}{EBIT}$

Substitute the value in formula

1.25 = $\frac{x}{200000}$ (Let consider Contribution be X)

1.25 * 200000 = X

Contribution = Rs. 2,50,000

To calculate the P/V ratio

P/V ratio = $\frac{Contribution}{Sales} * 100$

= $\frac{2,50,000}{10,00,000} * 100$

= 25%

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