Question 1 OR (b)
Leverages of Delta Limited and the effect on EPS of a 7% rise in sales
9 marks
- Time to write
- About 18 minutes
Question
Question 1 OR (b) · 9 marksConsider the given information for Delta Limited
| (₹ Lakhs) | |
|---|---|
| Sales (70% of Variable cost) | 9600 |
| EBIT | 2340 |
| PBT | 1140 |
| Tax rate | 20% |
Calculate the different type of leverages. Calculate the percentage change in earning per share. In case sales increases by 7%.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- Calculate…Two asks in one question: answer both.
- CalculateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
"Sales (70% of Variable cost)" is read as variable cost being 70% of sales, which is what the other figures allow. The fragment "In case sales increases by 7%." is read as belonging to the request for the percentage change in earning per share.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Contribution, fixed cost and interest 2 marks 4 min
- 2 Operating, financial and combined leverage 4 marks 7 min
- 3 Change in EPS for a 7% rise in sales 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Try it first. About 18 minutes for 9 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Reading (paper note). Variable cost is taken as 70% of sales.
1The baker signs for the bank's money at a fixed interest.
Financial leverageThe use of fixed-charge funds (debt, preference shares) in the capital structure.
2The ovens run full, the queue is long—the loan earns more than it costs, and the owner's share swells.
FavourableThe fixed-charge funds earn more than they cost, so EPS rises.
3The same counter empty: the interest envelope still goes out, from a thinner cash box.
UnfavourableWhen ROI is below the cost of debt: EPS falls.
| (₹ lakhs) | |
|---|---|
| Sales | 9,600 |
| Less: variable cost (70%) | 6,720 |
| Contribution | 2,880 |
| Less: fixed cost (balancing figure) | 540 |
| EBIT | 2,340 |
| Less: interest (balancing figure) | 1,200 |
| PBT | 1,140 |
- Operating leverage = contribution ÷ EBIT = 2,880 ÷ 2,340 = 1.2308.
- Financial leverage = EBIT ÷ PBT = 2,340 ÷ 1,140 = 2.0526.
- Combined leverage = contribution ÷ PBT = 2,880 ÷ 1,140 = 2.5263 (= 1.2308 × 2.0526).
Change in EPS for a 7% rise in sales. Combined leverage gives the % change in EPS for a 1% change in sales; with the tax rate (20%) and number of shares constant, EPS moves in proportion to PBT:
% change in EPS = 2.5263 × 7% = 17.68%.
Check: sales 10,272 → contribution 3,081.60 − fixed 540 − interest 1,200 = PBT 1,341.60, which is 17.68% above 1,140.
Where the 9 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Contribution, fixed cost and interest | 2 |
| 2 | Operating, financial and combined leverage | 4 |
| 3 | Change in EPS for a 7% rise in sales | 3 |
| Total | 9 |
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