The document discusses various types of leverage in financial management, including operating leverage, financial leverage, and combined leverage, along with their formulas and calculations. It provides a numerical example to illustrate how to calculate these leverage degrees using specific values for sales, costs, and interest expenses, deriving insights on their implications for business leverage. Additionally, it explains the effects of changes in earnings before interest and tax (EBIT) and sales on earnings per share (EPS) using percentage increases.

1. TYPES OF LEVERAGE
FINANCIAL MANAGEMENT

2. TYPES OF LEVERAGE
Operating
Leverage
Financial
Leverage
Combined
Leverage

3. FORMULAS
Sales – Variable cost = Contribution
Contribution – Fixed cost = Earning before interest and tax
Earning before Interest and tax – Interest = Earning before Tax
Earning before tax – Tax = Earning after Tax
Earning per share = Earning after Tax / No. of Shares

4. FORMULAS
• Degree of Operating Leverage = Contribution / EBIT
• Degree of Operating Leverage = % change in EBIT/ % change in sales
• Degree of Financial Leverage = EBIT/ EBT
• Degree of Financial Leverage = % change in EPS / % change in EBIT
• Degree of Combined Leverage = OL * FL
• Degree of Combined Leverage = % change in EPS / % change in Sales

5. NUMERICAL EXAMPLE – CALCULATE DEGREE OF
OPERATING, FINANCIAL AND COMBINED LEVERAGES
Particulars Values
Units 50000
Fixed Cost $10000
Variable cost per unit $ 0.20
Interest Expense $ 2000
Selling Price per unit $ 0.50

6. SOLUTION
• Sales = No. of units * Selling price per unit
 50000* 0.50 = $25000
• Variable cost = No. of units * Variable cost per unit
 50000*0.20 = $10000

7. DEGREE OF OPERATING LEVERAGE
• Degree of Operating Leverage = Contribution / EBIT
• Contribution= Sales – Variable Cost= 25000-10000=15000
• EBIT= Sales – (Variable cost + Fixed cost) = 25000-
(10000+10000) = 5000
• DOL= 15000 / 5000 = 3

8. DEGREE OF FINANCIAL LEVERAGE
• Degree of Financial Leverage = EBIT/ EBT
• EBIT = 5000
• EBT = EBIT – Interest Expenses= 5000- 2000=3000
• DFL= 5000/3000 = 1.67

9. DEGREE OF COMBINED LEVERAGE
• Degree of Combined Leverage = DOL * DFL
• DCL= 3 * 1.67 = 5.01
Interpretaion- The business is more leveraged because of the
presence of fixed operating cost where the degree of
operating leverage is 3, higher as compared to the financial
burden of 1.67

10. USING THE PERCENTAGE FORMULA
• Suppose with the same data given if you are required to find-
1. % change in EPS if EBIT increases by 5%
2. % change in EBIT if sales increases by 10%
3. % change in EPS if sales increases by 10%

11. SOLUTION
1. Degree of Financial Leverage = % change in EPS / % change in EBIT
=> % change in EPS = DFL * % change in EBIT = 1.67 * 5 = 8.35%
2. Degree of Operating Leverage = % change in EBIT/ % change in sales
=> % change in EBIT = DOL* % change in sales = 3 * 10 = 30%
3. Degree of Combined Leverage = % change in EPS / % change in Sales
=> % change in EPS = DCL * % change in Sales = 5.01 * 10 = 50.1%

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