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94 Financial Management WCL = Percentage Change in ROI Percentage Change is WC If the earnings are not affected by the changes in current assets, the working capital leverage can be calculated with the help of the following formula. Where, CA = Current Assets TA = Total Assets WCL = CA TA ± DCA DCA = Changes in the level of Current Assets Exercise 7 The following information is available for two companies. X Ltd. Y Ltd. Fixed Assets Rs. 4,00,000 1,00,000 Current Assets Rs. 10,00,000 4,00,000 Total Assets Rs. 14,00,000 14,00,000 Earning before interest and taxes Rs. 1,50,000 1,50,000 You are required to compare the sensitivity earnings of the two companies for 30% charge in the level of their current assets. Solution Working capital leverage = Current Assets Total Assets ± DCA X Ltd. = Y Ltd. = 1,00,000 14,00,000 – 3,00,000 = 10,00,000 11,00,000 = 0 .90 4,00,000 14,00,000 – 1,20,000 = 4,00,000 12,80,000 = 0.3125
Leverage 95 Looking at the working capital leverage of the two companies, we can say that the sensitivity of earnings for charge on the level of current assets of X Ltd. is a greater than of Y Ltd. Exercise 8 Calculate operating leverage and financial leverage under situations A, B and C and financial plans 1, 2 and 3 respectively from the following information relating to the operating and financial leverage which give the highest value and the least value. Installed capacity (units) 1,200 Actual production and sales (units) 800 Selling price per unit (Rs.) 15 Variable cost per unit (Rs.) 10 Fixed costs (Rs.) Situation A 1,000 Situation B 2,000 Situation C 3,000 Capital Structure Financial Plan 1 2 3 Equity Rs. 5,000 Rs. 7,500 Rs. 2,500 Debt Rs. 5,000 Rs. 2,500 Rs. 7,500 Cost of debt 12 per cent (for all plans) (MBA – P.U. Nov. 2005) Solution A B C S – VC 4,000 4,000 4,000 EBIT 3,000 2,000 1,000 DOL = S− VC EBIT 1.33 2 4 1 2 3 Situation A EBIT 3,000 3,000 3,000 Less : Interest 600 300 900 EBT 2,400 2,700 2,100 Financial Leverage 1.25 1.11 1.43 Situation B EBIT 2,000 2,000 2,000 Less : Interest 600 300 900
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Preface Financial Management is an
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Contents • Increase the value of
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Contents • Effects of under capit
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Contents Modigliani and Miller’s
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Contents • Average stock level 16
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Contents • Operational result of
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Contents Insurance Sector in India
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2 Financial Management According to
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4 Financial Management SCOPE OF FIN
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6 Financial Management 3. Profit is
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8 Financial Management Traditional
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10 Financial Management Proper Use
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12 Financial Management Financial S
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16 Financial Management Solution Co
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18 Financial Management Exercise 3
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20 Financial Management Solution Sc
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28 Financial Management SECURITY FI
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34 Financial Management Features of
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36 Financial Management financial y
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150 Financial Management Capital Fi
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152 Financial Management Working Ca
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154 Financial Management NEEDS OF W
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(A) First in First out Method FIFO
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188 Financial Management (iv) (v) H
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