This document provides an overview of leverages including operating leverage, financial leverage, and combined leverage. It defines leverage as using assets or funds to pay fixed returns. It discusses the differences between debt and equity financing. It also covers various leverage concepts like trading on equity, break-even analysis, EBIT-EPS analysis, and measures of operating and financial leverage. The document aims to introduce students to important leverage concepts and their applications in financial management.

1. NAGINDAS KHANDWALA
COLLEGE

2. FINANCIAL
MANAGEMENT 2

3. LEVERAG
ES

4. GROUP NO.1
NAMES ROLL NO.
TRIPTI. BANGERA 1
KARISHMA. BHANDARI 2
RAJAT. BHOIR 3
GOPI.CHAUHAN 4
KHUSHBOO. CHAURASIA 5
RUSHABH DEDHIA 6
JAINAM.DELIWALA 7
RUTU. DOBARYA 8
POOJA GADA 10
JINAL GAGLANI 11

5. TABLE OF
CONTENTSR NO. PARTICULARS
1. Introduction and meaning of leverages
2. Debt vs equity financing
3. Business risk and financial risk
4. Types of leverages- operating leverage
5. Financial leverage
6. Trading on equity
7. Combined leverage
8. Break-even point
9. EBIT- EPS Analysis
10. Measures of operating and financial
leverage
11. Importance of leverages

6. INTRODUCTION TO LEVERAGE
LEVER MEANS A BAR RESTING ON A PIVOT WHICH IS
USED TO RAISE A HEAVIER OBJECT.WHEN A LEVER IS
USED PROPERLY , A FORCE APPLIED AT ONE POINT IS
TRANSFORMED , OR MAGNIFIED , INTO ANOTHER
LARGE FORCE OR MOTION AT SOME OTHER POINT. IN
SHORT , THE FUNCTION OF LEVER IS TO RAISE A
HEAVY OBJECT WITH A MINIMUM FORCE

7. DEFINITION OF LEVERAGE
LEVERAGES IS THE EMPLOYMENT
OF THE ASSETS OR FUND FOR
WHICH THE FIRM PAYS THE FIXED
RETURNS

8. DEBT V/S EQUITY FINANCING
• LENDER REUIRE A LOWER RATE OF RETURN THAN
ORDINARY SHAREHOLDER.
• A PROFITABLE BUSINESS LESS PAY FOR DEBT THAN
EQUTY.
• ISSUING AN TRANSACTIONS COST.

9. RISK
MEANING
TYPES OF RISK
• BUSINESS RISK
• FINANCIAL RISK

10. BUSINESS
RISK
• MEANING
• VARIABILITY
• NATURE OF RISK
• MEASUREMENT
• CHANGE IN CAPITAL STRUCTURE
• LINKED TO

11. FINANCIAL
RISK
• MEANING
• VARIABILITY
• NATURE OF RISK
• MEASUREMENT
• CHANGE IN CAPITAL STRUCTURE
• LINKED TO

12. TYPES OF
LEVERAGE
OPERATING
LEVERAGE
FINANCIAL
LEVERAGE
COMBINED
LEVERAGE

13. WHAT IS OPERATING
LEVERAGE ?
•MEASURES COMPANY FIXED TO ITS VARIABLE
COST
•USED TO EVALUATE BREAK EVEN POINT OF A
BUSINESS

14. TWO SCENARIO OF OPERTING
LEVERAGE
HIGH OPERATING
LEVERAGE
LOW OPERATING
LEVERAGE
• COSTS ARE FIXED
COST
• SALES ARE VARIABLE
COST

15. DEGREE OF OPERATING
LEVERAGE
DOL = CONTRIBUTION
EBIT

16. WHAT DOES IT TELL
US ?
• IF DOL = 2 , THEN 1 % INCREASE IN SALES WILL RESULT IN 2 %
INCREASE
IN OPERATING INCOME ( EBIT)
SALES EBIT

17. EFFECTS OF OPERATING
LEVERAGE
MORE OPERATING LEVERAGE LEADS TO
MORE BUSINESS RISK FOR THAN A SMALL
SCALE DECLINE CAUSES A BIG PROFIT
DECLINE

18. FINANCIAL
LEVERAGE
•IT IS DEFINED AS THE USE OF FUNDS WITH A FIXED
COST IN ORDER TO INCREASE EARNING PER
SHARE
•​FINANCIAL LEVERAGE IS A MEASURE OF
FINANCIAL RISK
•​AND THERE WILL BE NO FINANCIAL LEVERAGE IF
THERE IS NO FIXED CHARGE FINANCING.​

19. DEGREE OF FINANCIAL LEVERAGE (
FORMULA)
STATIC. DYNAMIC
IN EPS
INEBI
T
EBIT
EBT

20. DEGREE OF FINANCIAL LEVERAGE
IF WE HAVE THE DATA, WE CAN USE
FOLLOWING FORMULA
DFL= EBIT
EBIT- INTEREST
HERE, I =AMOUNT OF INTEREST CHARGES​

21. WHAT DOES IT TELL US ?
IF DFL = 3, THEN A 1% INCREASE IN OPERATING INCOME WILL RESULT
IN A 3% INCREASE IN EARNING PER SHARE
IF DFL = % CHANGE IN EPS
% CHANGE IN EBIT
SALES EBIT EPS STOCKHOLDER

22. EFFECTS OF DFL
Firm A
EBIT. 100
- Interest. 10
EBT. 90
DFL = EBIT
EBT
= 100
90
= 1.11
Firm B
EBIT. 100
- Interest. 50
EBT. 50
DFL = EBIT
EBT
= 100
50
= 2

23. FROM THE EXAMPLE WE COME TO KNOW
THAT
IF INTEREST IS LOW, DFL WILL BE LOW
AND
IF INTEREST IS HIGH, DFL WILL BE HIGH

24. IMPORTANCES OF FINANCIAL
LEVERAGE
•IT IS USE TO FIND EPS AND MARKET VALUE OF
EQUITY SHARE
•​IT IS SUPERIOR THAN OPERATING LEVERAGE
•​IT IS USE TO MAKE FINANCIAL DECISIONS

25. TRADING ON
EQUITY
 EQUITY MEANS EQUITY SHARES
 TRADING MEANS ‘TAKING ADVANTAGE OF’.
 REFERRED TO AS FINANCIAL LEVERAGE
 USE OF OWNER’S FUND AS WELL AS BORROWED FUNDS
WITH A VIEW TO INCREASE THE EPS
 COMPANY IS MAKING USE OF FIXED INTEREST AND
DIVIDEND BEARING SECURITIES TO BENEFIT EQUITY
SHAREHOLDERS.

26. CAPITAL STRUCTURE
PARTICULARS DIAMOND
LTD. (AMT.)
GOLD LTD.
(AMT.)
SILVER LTD.
(AMT.)
EQUITY SHARES OF RS. 100 EACH 2,00,000 8,00,000 10,00,000
10% DEBENTURES OF RS.100 EACH 8,00,000 - -
8% PREFERENCE SHARES OF RS. 100
EACH
- 2,00,000 -
TOTAL CAPITAL EMPLOYED 10,00,000 10,00,000 10,00,000

27. INCOME STATEMENT (WHEN ROCE IS
30%)
Particulars Diamond Ltd.
(Amt.)
Gold Ltd.
(Amt.)
Silver Ltd.
(Amt.)
EBIT @30% 3,00,000 3,00,000 3,00,000
(-)Interest (80,000) NIL NIL
EBT 2,20,000 3,00,000 3,00,000
(-)Tax @50% (1,10,000) (1,50,000) (1,50,000)
EAT / NPAT 1,10,000 1,50,000 1,50,000
(-)Preference dividend NIL (16,000) NIL
Profit for Equity Shareholders 1,10,000 1,34,000 1,50,000
÷ No. of Equity shares 2000 8000 10000
Earnings Per Share
(EPS)
Rs.55/- Rs.16.75/- Rs.15/-

28. DIAMOND LTD
Equity shares 10% Debt
2,00,000 @ 30% 8,00,000 @30%
EBIT 60,000 2,40,000
- Interest NIL (80,000)
EBT 60,000 1,60,000
- Tax@50% (30,000) (80,000)
EAT / NPAT 30,000 80,000
- Pref. Dividend NIL NIL
NP for ESH 30,000 80,000
+ 80,000
1,10,000

29. GOLD LTD
EQUITY SHARES 8 % PREF. SHARES
8,00,000 @ 30% 2,00,000 @30%
EBIT 2,40,000 60,000
INTEREST NIL NIL
EBT 2,40,000 60,000
TAX@50% (1,20,000) (30,000)
EAT / NPAT 1,20,000 30,000
PREF. DIVIDEND NIL (16,000)
NP FOR ESH 1,20,000 14,000
+ 14,000
1,34,000

30. ROCE > Interest Rate

31. INCOME STATEMENT (WHEN ROCE IS 8
%)
Particulars Diamond
Ltd.
(Amt.)
Gold Ltd.
(Amt.)
Silver Ltd.
(Amt.)
EBIT @8% 80,000 80,000 80,000
(-)Interest (80,000) NIL NIL
EBT NIL 80,000 80,000
(-)Tax @50% NIL (40,000) (40,000)
EAT / NPAT NIL 40,000 40,000
(-)Preference dividend NIL (16,000) -
Profit for Equity
Shareholders
NIL 24,000 40,000

32. GOLD LTD
EQUITY SHARES 8 % PREF. SHARES
8,00,000 @ 8 % 2,00,000 @ 8 %
EBIT 64,000 16,000
INTEREST NIL NIL
EBT 64,000 16,000
TAX@50% (32,000) (8,000)
EAT / NPAT 32,000 8,000
PREF. DIVIDEND NIL (16,000)
NP FOR ESH 32,000 ( 8,000)
- 8,000
24,000

33. TRADING ON EQUITY
GENERATES HIGHER RETURNS TO EQUITY
SHAREHOLDERS, PROVIDED THE COMPANY’S -
ROCE > INTEREST RATE
PRESENTS THE RISKS OF OUTRIGHT BANKRUPTCY
OTHER BENEFITS

34. RELATIONSHIP BETWEEN OPERATING LEVERAGE AND
FINANCIAL LEVERAGE
OPERATING LEVERAGE FINANCIAL LEVERAGE
• Operating leverage is concerned with
investment activities of the firm.
• Financial leverage is concerned with
financing activities of the firm.
• It is determined by the cost structure of the firm. • It is determined by the capital structure of the
firm.
• It is the firm’s ability to use fixed operating costs
to magnify the effects of changes in sales on its
earnings before interest and taxes.
• It is the firm’s ability to use fixed financial
charges to magnify the effects of changes in
EBIT on its earnings per share.
• Degree of operating leverage enables us to
measure the business risk associated with the
firm.
• Degree of financial leverage enables us to
measure the degree of financial risk,
associated with the firm.
• DOL = Contribution
EBIT
• DFL = EBIT
EBT

35. COMBINED LEVERAGE
• INTRODUCTION
• DEGREE OF COMBINED LEVERAGE
• PRODUCT OF OPERATING LEVERAGE AND FINANCIAL
LEVERAGE

36. DEGREE OF COMBINED
LEVERAGE
• DEGREE OF COMBINED LEVERAGE:
= DEGREE OF OPERATING LEVERAGE(DOL) * DEGREE OF FINANCIAL
LEVERAGE(DFL)

37. DEGREE OF COMBINED
LEVERAGE
• DEGREE OF COMBINED LEVERAGE (DCL):
OR
DCL =
CONTRIBTION
EBT
DCL = % CHANGE IN EPS
% CHANGE IN SALES

38. COMBINED
LEVERAGE
• WHEN DCL = % CHANGE IN EPS
% CHANGE IN SALES
• THEN IF DCL = 4, THEN A 1% INCREASE IN SALES
WILL RESULT IN A 4% INCREASE IN EARNINGS PER
SHARE

39. BREAK EVEN
ANALYSIS

40. DEFINITION
• THE POINT WHERE GAINS EQUAL THE LOSSES
• POINT WHERE INVESTMENT WILL GENERATE POSITIVE
RETURNS
• SALES OR REVENUE EQUALS LOSSES

41. FORMULA
Break even Point = Fixed Cost
Contribution
Where,
Contribution = Selling cost – Variable cost
Fixed cost = Contribution - Profit

42. GRAPHICAL VIEW

43. EBIT-EPS ANALYSIS
INTRODUCTION
 EBIT – EPS ANALYSIS IS AN APPROACH WHICH HELPS IN
DESIGNING THE OPTIMUM CAPITAL STRUCTURE FOR THE
COMPANY OR THE FIRM.
 TO DESIGN VARIOUS ALTERNATIVES OF DEBT, EQUITY AND
PREFERENCE TO MAXIMIZE THE EPS .

44. CALCULATION OF
EPS

46. MEASURES OF OPERATING LEVERAGE
FIXED COSTS TO TOTAL
COSTS
PERCENTAGE CHANGE IN OPERATING
INCOME TO THE PERCENTAGE CHANGE IN
SALES
NET INCOME TO FIXED
COSTS

47. MEASURES OF FINANCIAL LEVERAGE
DEBT TO ASSETS RATIO
DEBT TO EQUITY RATIOINTEREST COVERAGE RATIO

48. IMPORTANCE OF OPERATING LEVERAGE & FINANCIAL
LEVERAGE
MEASUREMEN
T OF
OPERATING
RISK
MEASUREMEN
T OF
FINANCIAL
RISK MANAGING
RISK
DESIGNING
APPROPRIATE
CAPITAL STRUCTURE
MIX

49. INCREASE
PROFITABILIT
Y
MAGNIFICATION
OF
SHAREHOLDER
PROFITS IMPROVEMENT
IN CREDIT
RATING
CAPTURING
ECONOMIES
OF SCALE
INCREASED
FREE CASH

50. LEVERAGES – PRO’S & CON’S
1. CREDIT RATING IMPROVES
2. ECONOMIES OF SCALE
3. CAH AVAILABILITY
4. INCREASE SHAREHOLDER’S EQUITY
5. FINANCIAL RISK
6. BIGGER LOSSES

51. CONCLUSIO
N