Introduction:
There are two Companies P and R with similar type of business operations. Company P financed all operations by equity and Company R used equity and debt of 50 % each. The other parameters are :
Sales revenue Rs. 1 Crore
Selling Price Rs.160 unit
Variable cost Rs.100
Fixed cost Rs. 25,00,000
Interest on debt for Company R Rs. 2,50,000
You are supposed to calculate the degree of operating, financial and combined leverage.
By going through this chapter on leverages, it will help students or finance manager to answer the below given questions to make the financial decisions: How to analyse the combined effect of financial and operating leverage? How should the investment project be financed How does financing effect the
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The variables will have a mix of cost with profit, sales with profit or EBIT with EPS. Leverage helps to increase the profitability of the company with the use of fixed cost.
Definition of According to James Horne “the employment of assets or funds for which the firm pays a fixed cost or fixed return “. Figure 3.1: Leverage in Finance
Source: http://www.civilserviceindia.com/subject/Management/notes/financial-and-operating-leverage.html
It can be shown in this way as % change in one variable (dependent) and divided by % change in another variable (independent). It is represented in this form:
Leverage = (% Change of dependent Variable)/(% change of independent variable)
Example: A company increases its sales revenue from 10,000 to 20,000 of a particular month with the increase in advertisement expenses from 2,000 to 3,000. The leverage between both the variables are shown as given below:
Leverage expenditure = (% change in sales revenue)/(% change in Advertisement expenditure)
= (% change in sales revenue)/(% change in Advertisement expenditure) = (100%)/(20%) =
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