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CA Final · Advanced Financial Management · Risk Management

Vikram Auto Ltd has sales of ₹200 crore, variable costs of ₹120 crore and fixed operating costs of ₹40 crore. Interest is ₹10 crore. Considering business risk and financial risk through leverage, which statement is correct?

Combined leverage is 2.67, made up of operating leverage of 2.00 and financial leverage of 1.33. Contribution is ₹80 crore, EBIT is ₹40 crore and profit before tax is ₹30 crore, so 80/40 times 40/30 equals 80/30, which is 2.67.

  1. ADegree of combined leverage is 2.67 and arises from DOL of 2.00 and DFL of 1.33Correct
  2. BDegree of combined leverage is 2.00 and arises from DOL of 1.50 and DFL of 1.33
  3. CDegree of combined leverage is 2.67 and arises from DOL of 1.50 and DFL of 1.78
  4. DDegree of combined leverage is 3.20 and arises from DOL of 2.00 and DFL of 1.60

Explanation

Contribution = 200 − 120 = 80. EBIT = 80 − 40 = 40. DOL = 80/40 = 2.00. EBT = 40 − 10 = 30, DFL = 40/30 = 1.33. DCL = 2.00 × 1.33 = 2.67, which also equals 80/30. Other options misstate DOL or DFL, for example using EBIT in the numerator of DOL.

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