Calculate the Operating Leverage, Financial Leverage and Combined Leverage from the following data under situation I and II and Financial Plan A & B.

 To calculate Operating Leverage, Financial Leverage, and Combined Leverage, we need to understand the formulas for each leverage type:

1. Operating Leverage (OL): Operating Leverage measures the sensitivity of operating income to changes in sales. It indicates the extent to which fixed costs are used in the production process. The formula for Operating Leverage is:

Operating Leverage (OL) = Contribution Margin / Operating Income

Contribution Margin = (Sales - Variable Costs)

Operating Income = (Sales - Variable Costs - Fixed Costs)

2. Financial Leverage (FL): Financial Leverage measures the impact of financial structure (debt and equity) on the company's earnings per share (EPS). It shows how much the company's net income changes for a given percentage change in operating income. The formula for Financial Leverage is:

Financial Leverage (FL) = Earnings Before Interest and Taxes (EBIT) / Operating Income

EBIT = (Sales - Variable Costs - Fixed Costs)

3. Combined Leverage (CL): Combined Leverage is the product of Operating Leverage and Financial Leverage. It indicates the overall sensitivity of EPS to changes in sales. The formula for Combined Leverage is:

Combined Leverage (CL) = Operating Leverage * Financial Leverage

Let's calculate the Operating Leverage, Financial Leverage, and Combined Leverage for Situation I and II and Financial Plan A & B.

Situation I:

Fixed Cost = Rs. 15,000 Capacity = 4000 units Actual Production & Sales = 75% of Capacity = 0.75 * 4000 = 3000 units Selling Price = Rs. 30 per unit Variable Cost = Rs. 15 per unit

Calculation: Sales = Selling Price * Actual Production & Sales = Rs. 30 * 3000 = Rs. 90,000 Variable Costs = Variable Cost * Actual Production & Sales = Rs. 15 * 3000 = Rs. 45,000 Contribution Margin = Sales - Variable Costs = Rs. 90,000 - Rs. 45,000 = Rs. 45,000 Operating Income = Contribution Margin - Fixed Costs = Rs. 45,000 - Rs. 15,000 = Rs. 30,000

Operating Leverage (OL): Operating Leverage (OL) = Contribution Margin / Operating Income OL = Rs. 45,000 / Rs. 30,000 = 1.5

Financial Leverage (FL): Financial Leverage (FL) = EBIT / Operating Income FL = Operating Income / Operating Income = 1

Combined Leverage (CL): Combined Leverage (CL) = Operating Leverage * Financial Leverage CL = 1.5 * 1 = 1.5

Situation II:

Fixed Cost = Rs. 20,000 Capacity = 4000 units Actual Production & Sales = 75% of Capacity = 0.75 * 4000 = 3000 units Selling Price = Rs. 30 per unit Variable Cost = Rs. 15 per unit

Calculation: Sales = Selling Price * Actual Production & Sales = Rs. 30 * 3000 = Rs. 90,000 Variable Costs = Variable Cost * Actual Production & Sales = Rs. 15 * 3000 = Rs. 45,000 Contribution Margin = Sales - Variable Costs = Rs. 90,000 - Rs. 45,000 = Rs. 45,000 Operating Income = Contribution Margin - Fixed Costs = Rs. 45,000 - Rs. 20,000 = Rs. 25,000

Operating Leverage (OL): Operating Leverage (OL) = Contribution Margin / Operating Income OL = Rs. 45,000 / Rs. 25,000 = 1.8

Financial Leverage (FL): Financial Leverage (FL) = EBIT / Operating Income FL = Operating Income / Operating Income = 1

Combined Leverage (CL): Combined Leverage (CL) = Operating Leverage * Financial Leverage CL = 1.8 * 1 = 1.8

Financial Plan A:

Equity = Rs. 10,000 Debt = Rs. 10,000 Interest Rate on Debt = 20%

Calculation: Interest on Debt = Debt * Interest Rate = Rs. 10,000 * 0.20 = Rs. 2,000 EBIT = Operating Income = Rs. 30,000 (from Situation I)

Financial Leverage (FL): Financial Leverage (FL) = EBIT / Operating Income FL = Rs. 30,000 / Rs. 30,000 = 1

Financial Plan B:

Equity = Rs. 15,000 Debt = Rs. 5,000 Interest Rate on Debt = 20%

Calculation: Interest on Debt = Debt * Interest Rate = Rs. 5,000 * 0.20 = Rs. 1,000 EBIT = Operating Income = Rs. 25,000 (from Situation II)

Financial Leverage (FL): Financial Leverage (FL) = EBIT / Operating Income FL = Rs. 25,000 / Rs. 25,000 = 1

In both financial plans A and B, the Financial Leverage (FL) remains the same, as it is the ratio of EBIT to Operating Income, which is constant.

Summary of Leverage:

Situation I:

• Operating Leverage (OL) = 1.5
• Financial Leverage (FL) = 1
• Combined Leverage (CL) = 1.5

Situation II:

• Operating Leverage (OL) = 1.8
• Financial Leverage (FL) = 1
• Combined Leverage (CL) = 1.8

Financial Plan A:

• Financial Leverage (FL) = 1

Financial Plan B:

• Financial Leverage (FL) = 1

The Operating Leverage (OL) and Combined Leverage (CL) are different in situations I and II, indicating the sensitivity of operating income and EPS to changes in sales and fixed costs. The Financial Leverage (FL) remains the same in both situations as it depends on the capital structure and debt level, which is constant in financial plans A and B. The choice of financial plan affects the risk and return profile of the company, as higher leverage may amplify profits during good times but also increase losses during downturns.

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