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Leverage and sharia law b.v.raghunandan


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Leverage and sharia law b.v.raghunandan

  1. 1. Leverages and Sharia LawDepartment of Post Graduate Studies in Commerce, Besant College, Mangalore March 1, 2013
  2. 2. Leverage• Leverage was a later name given to cost- volume-profit analysis• Costs were divided into fixed costs and variable costs-the behaviour to the changes in volume of production or sale• Economists derived the concept called Break Even Point contributing managerial decision- making tool
  3. 3. BEP Chart
  4. 4. Limitation of the Analysis• Relevant Range of Activity• The classification of costs hold good upto a given volume• Beyond that, the fixed cost also becomes variable• Supervisor’s salary/Foremen’s Salary, Depreciation on Machines, Factory Rent, Project Cost itself
  5. 5. Different Analysis• For economists, the cost and sales figures represented by curves (curvy-linear) leading to qualitative analysis• For developing quantitative analysis, we treat them as linear represented by straight lines• In the early 1940s, many physics professors tried to contribute to conversion of economic laws into the precision of physics equations
  6. 6. CVP Analysis becomes Operating Leverage• The physicists called the benefit derived through the presence of fixed cost as leverage• Leverage can be in operation or in the sourcing of finance• The benefit is an increase in sale resulting in a higher increase in net operating income or EBIT (operating leverage) and the higher net income (EBIT) results in still higher Earning per Share (EPS)
  7. 7. Significance of Operating Leverage• Sales-Operating Profit (EBIT) Relation• Role of Fixed Cost• Measurement of Operating Risk
  8. 8. Statement of Income Amount Rs.• Sales.... --------• (-) Variable Cost.. ___________ Contribution....• (-) Fixed Cost.... _____________ Operating Profit/Earning Before Interest• And Tax (EBIT) (-) Interest on Debt Securities Like• Debentures, Bonds, Long Term Loans _____________ Earning Before Tax (EBT)• (-) Tax ______________ Earning After Tax (EAT)• (-) Preference Dividend ______________ Surplus Profit ______________
  9. 9. Computation of Operating Leverage Contribution Operating Leverage =---------------------- EBIT %ofChangeinEBITDegreeofOp .Leverage %ofChangeinSales
  10. 10. Calculation of Operating Leverage• Calculate the operating leverage from the following details: Sales 10,000 units; Variable Cost Rs.7 per unit; Price per unit Rs.10 and Fixed Cost –Rs.20,000. With the help of operating leverage, calculate the percentage of increase in EBIT for an increase of 10% in sales
  11. 11. Financial Leverage• Fixed cost in the operation creates a magnified impact of change in sales on the operating profit (EBIT).• In the same way, there is also a fixed factor on the capital structure of the company.• All the debt securities and preference shares are to be paid the interest / dividend at a fixed rate.• when EBIT increases, interest and dividend on preference shares do not change consequently.• The Earning per share (EPS) changes to a greater extent for a given change in the operating profit (EBIT). This is called Financial Leverage
  12. 12. Leverages↑ Sales > ↑EBIT > ↑ EPS
  13. 13. Calculation of Financial Leverage EBIT FinancialLeverage EBT %ofchangeinEPSDegreeofFL %ofChamgeinEBIT
  14. 14. Computation of Financial Leverage• Murthy Valves Ltd manufactures polyurethane valves for industrial usage.Utilized capacity 1,000 units; Selling prices Rs. 116 per unit; Variable Cost Rs. 56 per unit; Fixed Cost Rs. 30,000; Interest on loan Rs. 10,000; Tax rate 50%When the sales increases by 20%, 40% or 50%, what will be the impact on Operating Profit and EPS?
  15. 15. Leverages & Revisiting Equity Culture• No Impact on Zero Debt Companies• Irrelevant for Cash Rich Companies• Recapitalisation of PSU Banks by Government in the light of Basel Norms Compliance• Debt is resorted as a Last Resort• Loses significance in the light of Restructuring of Companies• Entry of Venture Capital, Private Equity and Angel Investment• Benefit of Listed Companies
  16. 16. Distortions in Financial Management• Preference Shares form the first Distortion• Comparison of Equity Shares and Debt on the basis of cost of capital• Ignorance of Adverse Impact of Leverages in case of Losses• Long-Term Debt• Debt is not a source of finance, but a toxic element of finance• Asset Financing, oblivious of income• Limited Liability Partnership
  17. 17. Sharia Law• Holds that borrowing and lending form an immoral practice• Allows profit sharing and not interest payment• Contributes to the principle of financial management• Basel Norms prescribe what is preached by Sharia• Mutual Funds introduce Schemes based on Islamic Investment principle• RBI rejected Islamic Banking
  18. 18. Significance of Sharia Principles• Avoidance of Risk Management and its Cost• Absorbing the Risk• In the long-run, avoidance of derivatives• Saving the Banking System from Excesses• Avoidance of Bankruptcy of Corporates• Saving People from the Culture of Borrowing• Accepting the Principle of losses borne by a large number of shoulders
  19. 19. THANK YOU