Question

what will be its new ebit if sales drop to 60,00,000​

Answer 1

Solution:

Given,

Sales = 85, 00,000

Variable Cost = 52, 00,000

Fixed Cost = 7, 00,000

Debts = 55, 00,000 (9%)

Equity Capital = 65, 00,000

Therefore, Contribution = sales-variable cost = 85, 00,000-52, 00,000=33, 00,000

EBIT (Earnings before Interest and Tax) = Contribution-fixed cost

EBIT=33, 00,000-7, 00,000=26, 00,000

\text { operating Leverage }=\frac{\text {Contribution}}{\text {EBIT}}=\frac{33,00,000}{26,00,000}=1.27

\text {Financial Leverage}=\frac{\text {Debt}}{\text {Equity}}=\frac{55,00,000 \times \frac{9}{100}}{65,00,000}=\frac{495000}{6500000}=0.076

\text { Combined Leverage }=\text { operating Leverage } \times \text { Financial Leverage }=1.27 \times 0.076=0.097

New EBIT after sales drop,

EBIT= 60, 00,000-52, 00,000-7, 00,000=1, 00,000

New EBIT after sales drop is 1, 00,000

Answer 2

The operating, financial and combined leverage is 1.27, 0.076 and 0.097 respectively

The new EBIT if sales drop to 60,00,000 is 1,00,000

Explanation:

a. The computation of the operating leverage is shown below:

= (Sales - Variable costs) ÷ (Sales - Variable costs - Fixed costs)

= (85,00,000 - 52,00,000) ÷ (85,00,000 - 52,00,000 - 7,00,000)

= 33,000,000 ÷ 26,00,000

= 1.27

The (Sales - Variable costs) = Contribution margin

The  (Sales - Variable costs - Fixed costs) = EBIT

b. The computation of the financial leverage is shown below:

= (Debt) ÷ (Equity)

where,

Debt is

= Debt × interest rate

= 55,00,000 ×9%

= 4,95,000

And, the equity is 65,00,000

So, the financial leverage is

= 4,95,000 ÷ 65,00,000

= 0.076

c. The computation of the combined leverage is shown below:

= Operating leverage × Financial leverage

= 1.27 × 0.076

= 0.097

And, the new EBIT is

= Sales - Variable costs - Fixed costs

= 60,000,000 - 52,00,000 - 7,00,000

= 1,00,000

We simply applied the above formulas so the computation can be done in easily manner.

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