Description
Leverage and Cost Volume Profit Analysis
CONCEPT OF LEVERAGES
• What is Operating leverage? • Operating leverage is the increase in net profit ratio due to an increase in sales or activity level. Kohler defines it as the tendency of net profit to vary disproportionately with sales. OL = Contribution Op. profit or EBIT High OL = High Risk = High Break even point BEP (units) = Fixed costs / contribution p.u. BEP (Value) = Fixed costs / P/V ratio DOL = % change in EBIT % change in Sales when it exceeds 1
base Sales in units Sales revenue 2000
Case1 (50%) 3000
Case 2 -50% 1000 100000 50000
200000 300000
Less: variable cost 100000 150000
Contribution
Less: Fixed cost EBIT
100000 150000
50000 50000 50000 100000 +100%
50000
50000 0 -100%
Examples on OL and profitability
1. ROI or ROCE :24% existing sales : 3 lacs AT or CT ratio : 3 times net profit margin : 8% variable cost to sales : 77% CE : 1 lac other things being the same if the AT increases to 4 what is the OL, ROI and profit margin 2. Sales Rs.4000; VC Rs.2000 ; FC Rs.600 What is the OL? What does it mean? 3. A ltd. has an annual prod.capacity of sewing machines of 5000 units. The VC pu is 1600 and the SP is 2000. If the FC is Rs.5 lacs what is the BEP in units and value?
base EBIT Less:interest on bonds EBT Less: Taxes (35%) PAT Less: Pref.dividend 10000 2000 8000 2800 5200 2000
Case 1 +40% 14000 2000 12000 4200 7800 2000
Case 2 -40% 6000 2000 4000 1400 2600 2000
PAT – PD
EPS (1000 Eq.shares)
3200
3.2
5800
5.8
600
0.8
81.25% -81.25%
Financial leverage
• The capital structure of a company can have a magnifying effect on the return to equity shareholders. This effect is termed as FL • As per Kohler the tendency of residual net income to vary disproportionately with net income. FL = EBIT EBT Earnings to Equity sh.holers = (EBIT – INT) (1-T) – Preference dividend DFL = % change in EPS %change in EBIT when it exceeds 1 = EBIT_________ EBIT – I – DP/(1-T)
Examples of financial leverage
• Ordinary shares 1000 long term loans 3000 EBIT 600 less: interest 300 EBT 300 What is the financial leverage ? What happens if the operating profit increases by 100%? What happens if the Operating profit decreases by 75%?
INDIFFERENCE POINT
• (EBIT – I1) (1-T) = (EBIT – I1 –I2) (1-T) No. of shares No. of shares • E. shares v. P.shares with tax on dividend EBIT (1-T) = EBIT (1-T) – DP (1+dt) No.of E.S No. of E.S A firm wants to raise 30 Lacs which can be either through equity or 15L 10%NCDs & 15 lacs equity. X (1-0.35) = (X – 1.5) (1 - 0.35) 30,000 15,000 X = Rs. 3,00,000.
Indifference Point
Debt + Equity
Debt adv Equity
EPS Rs
6.5
Equity adv
EBIT Rs lacs 3
Characteristics of leverages
Characteristics of DOL • For each level of sales there is distinct DOL • DOL is undefined at BEP • If quantity sold <BEP, DOL will be negative Characteristics of DFL • Each level of EBIT has a distinct DFL • DFL is undefined at the financial BEP • DFL will be negative when EBIT < Financial BEP
EXAMPLE ON GEARING
• Debt / Equity – 1:4 • Capital employed 50 L • Debt 10L;S.Cap.40L PBIT 10.0 Interest 1.0 PBT 9.0 Tax 3.6 PAT 5.4 EPS Rs, 1.35
ROSF 13.5%
• Debt / Equity –4:1 • Capital employed 50L • Debt 40L; S.Cap.10 L PBIT 10.0 Interest 4.0 PBT 6.0 Tax 2.4 PAT 3.6 EPS Rs. 3.6 ROSF 36%
Combined leverage
• CL is the product of the OL and FL • CL = OL x FL • CL = C x OP = CON OP EBT EBT • A high OL and high FL combination is very risky. A company should therefore maintain a proper balance between these two leverages
doc_146088500.ppt
Leverage and Cost Volume Profit Analysis
CONCEPT OF LEVERAGES
• What is Operating leverage? • Operating leverage is the increase in net profit ratio due to an increase in sales or activity level. Kohler defines it as the tendency of net profit to vary disproportionately with sales. OL = Contribution Op. profit or EBIT High OL = High Risk = High Break even point BEP (units) = Fixed costs / contribution p.u. BEP (Value) = Fixed costs / P/V ratio DOL = % change in EBIT % change in Sales when it exceeds 1
base Sales in units Sales revenue 2000
Case1 (50%) 3000
Case 2 -50% 1000 100000 50000
200000 300000
Less: variable cost 100000 150000
Contribution
Less: Fixed cost EBIT
100000 150000
50000 50000 50000 100000 +100%
50000
50000 0 -100%
Examples on OL and profitability
1. ROI or ROCE :24% existing sales : 3 lacs AT or CT ratio : 3 times net profit margin : 8% variable cost to sales : 77% CE : 1 lac other things being the same if the AT increases to 4 what is the OL, ROI and profit margin 2. Sales Rs.4000; VC Rs.2000 ; FC Rs.600 What is the OL? What does it mean? 3. A ltd. has an annual prod.capacity of sewing machines of 5000 units. The VC pu is 1600 and the SP is 2000. If the FC is Rs.5 lacs what is the BEP in units and value?
base EBIT Less:interest on bonds EBT Less: Taxes (35%) PAT Less: Pref.dividend 10000 2000 8000 2800 5200 2000
Case 1 +40% 14000 2000 12000 4200 7800 2000
Case 2 -40% 6000 2000 4000 1400 2600 2000
PAT – PD
EPS (1000 Eq.shares)
3200
3.2
5800
5.8
600
0.8
81.25% -81.25%
Financial leverage
• The capital structure of a company can have a magnifying effect on the return to equity shareholders. This effect is termed as FL • As per Kohler the tendency of residual net income to vary disproportionately with net income. FL = EBIT EBT Earnings to Equity sh.holers = (EBIT – INT) (1-T) – Preference dividend DFL = % change in EPS %change in EBIT when it exceeds 1 = EBIT_________ EBIT – I – DP/(1-T)
Examples of financial leverage
• Ordinary shares 1000 long term loans 3000 EBIT 600 less: interest 300 EBT 300 What is the financial leverage ? What happens if the operating profit increases by 100%? What happens if the Operating profit decreases by 75%?
INDIFFERENCE POINT
• (EBIT – I1) (1-T) = (EBIT – I1 –I2) (1-T) No. of shares No. of shares • E. shares v. P.shares with tax on dividend EBIT (1-T) = EBIT (1-T) – DP (1+dt) No.of E.S No. of E.S A firm wants to raise 30 Lacs which can be either through equity or 15L 10%NCDs & 15 lacs equity. X (1-0.35) = (X – 1.5) (1 - 0.35) 30,000 15,000 X = Rs. 3,00,000.
Indifference Point
Debt + Equity
Debt adv Equity
EPS Rs
6.5
Equity adv
EBIT Rs lacs 3
Characteristics of leverages
Characteristics of DOL • For each level of sales there is distinct DOL • DOL is undefined at BEP • If quantity sold <BEP, DOL will be negative Characteristics of DFL • Each level of EBIT has a distinct DFL • DFL is undefined at the financial BEP • DFL will be negative when EBIT < Financial BEP
EXAMPLE ON GEARING
• Debt / Equity – 1:4 • Capital employed 50 L • Debt 10L;S.Cap.40L PBIT 10.0 Interest 1.0 PBT 9.0 Tax 3.6 PAT 5.4 EPS Rs, 1.35
ROSF 13.5%
• Debt / Equity –4:1 • Capital employed 50L • Debt 40L; S.Cap.10 L PBIT 10.0 Interest 4.0 PBT 6.0 Tax 2.4 PAT 3.6 EPS Rs. 3.6 ROSF 36%
Combined leverage
• CL is the product of the OL and FL • CL = OL x FL • CL = C x OP = CON OP EBT EBT • A high OL and high FL combination is very risky. A company should therefore maintain a proper balance between these two leverages
doc_146088500.ppt