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CA Final · Financial Reporting · Analysis of Financial Statements

Kaveri Auto Ltd has EBIT of Rs 8,00,000, interest expense of Rs 2,00,000 and fixed operating costs (included in computing EBIT) of Rs 4,00,000 apart from interest. Contribution is therefore Rs 12,00,000. What is the combined leverage (degree of operating leverage x degree of financial leverage)?

Combined leverage is 2.00. Operating leverage is contribution over EBIT, 12,00,000 divided by 8,00,000, or 1.5. Financial leverage is EBIT over profit before tax, 8,00,000 divided by 6,00,000, or 1.333. Their product is 2.00, equal to contribution divided by PBT.

  1. A1.50
  2. B2.00
  3. C2.50
  4. D3.00Correct

Explanation

DOL = Contribution/EBIT = 12,00,000/8,00,000 = 1.5. DFL = EBIT/(EBIT - interest) = 8,00,000/6,00,000 = 1.333. Combined = 1.5 x 1.333 = 2.00. Check: Contribution/(EBIT - interest) = 12,00,000/6,00,000 = 2.00. Option 1.50 is DOL alone.

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