ADVANCED FINANCIAL

MANAGEMENT
PROF. RAJIV CHANDRA
MBA (IIMA), ICWA, CS
SEMESTER 2
CLASS OF 2020
 ASSIGNMENT – 5 MARKS
• GROUPS
1. RIBHAV, RAGHAV,RAJAN, RAVI, RAHUL, PRANJAL,
PRAVEEN, DISHANK, RAHUL ARORA Q.5.1
2. PAWAN YADAV Q.5.2
3. PRIYANKA Q.5.3
4. YASH Q.5.4
5. RASHIKA, NEHA, PRAGATI, PALLAVI, RAHUL
LAKHANI, RITANSHU, RAJAT, RAJESHWAR Q.5.5
6. ? Q.5.7
DUE DATE : 31/10/2018
 OPERATING LEVERAGE
• HIGHER THE FIXED COST, HIGHER THE OPERATING LEVERAGE
• HIGHER THE DEBT, HIGHER IS THE FINANCIAL LEVERAGE
• SUPPOSE, A FIRM CAN CHOOSE BETWEEN 2 TECHNOLOGIES TO
MANUFACTURE A CERTAIN PRODUCT.
• TECH-A
• FIXED COST RS. 5 MILLION P.A.
• VARIABLE COST – RS. 60 PER UNIT
• PRICE - RS. 80 PER UNIT
• CONTRIBUTION – RS. 20 (80 – 60)
• TECH – B
• FIXED COST RS. 10 MILLION P.A.
• VARIABLE COST – RS. 40 PER UNIT
• PRICE - RS. 80 PER UNIT
• CONTRIBUTION – RS. 40 (80 – 60)
• CYCLICALITY OF REVENUES – CHECK IMPACT ON PROFITS
• REVENUES – 100 MILLION, 80 MILLION, 120 MILLION
 FINANCIAL LEVERAGE
• REFERS TO FIXED INTEREST COST.
• PBIT
• LESS: INTEREST ON DEBT
• PBT
• LESS: TAX
• PAT
• LESS: PREFERENCE DIVIDEND
• EQUITY EARNINGS
• HOW SENSITIVE IS EQUITY EARNINGS TO PBIT – OR
– HOW WILL EPS CHANGE WITH A CHANGE IN PBIT
 OPERATING LEVERAGE
EXAMPLE

PARTICULARS UNIT SALES SALES

QUANTITY KG. 500 600
S.P. RS./KG. 1000 1000
V.C. RS./KG. 500 500
F.C. RS. LAC 200000 200000
PBIT RS. LAC
 OPERATING LEVERAGE

REVENUE RS. LAC 500000 600000

V.COST RS. LAC 250000 300000

CONTRIBUTION RS. LAC 250000 300000

F.COST RS. LAC 200000 200000

PBIT RS. LAC 50000 100000

 FINANCIAL LEVERAGE
PARTICULARS CASE A-BASE CASE B+20% CASE C-20%

PBIT 50,000 60,000 20% 40,000 -20%

INTEREST 30,000 30,000 30,000

PBT 20,000 30,000 10,000

TAXES 50% 10,000 15,000 5,000

PAT 10,000 15,000 5,000

NO. OF EQ. SHARES 10,000 10,000 10,000

EPS 1.00 1.50 50% 0.50 -50%
 COMBINED OR TOTAL LEVERAGE
PARTICULARS UNIT SALES SALES
QUANTITY KG. 500 600
S.P. RS./KG. 1000 1000
V.C. RS./KG. 500 500
F.C. RS. LAC 200000 200000
PBIT RS. LAC
INTEREST 30000
PBT
TAXES 0.5
PAT
NO. OF EQ. SHARES 10000
EPS
 COMBINED OR TOTAL LEVERAGE
REVENUE RS. LAC 500000 600000

V.COST RS. LAC 250000 300000

CONTRIBUTION RS. LAC 250000 300000

F.COST RS. LAC 200000 200000

PBIT RS. LAC 50000 100000

INTEREST 30000 30000

PBT 20000 70000

TAXES 0.5 10000 35000

PAT 10000 35000

NO. OF EQ. SHARES 10000 10000

EPS 1 3.5
 TOTAL LEVERAGE
• DEGREE OF TOTAL LEVERAGE
• DTL = % CHANGE IN PBT/% CHANGE IN Q
• DTL (Q=500) = DOL * DFL =
CONTRIBUTION/PBT
• DOL = CONTRIBUTION/PBIT OR % CHANGE IN
EBIT/ % CHANGE IN SALES VOLUME
• DFL = PBIT/PBT
 EXAMPLE
PARTICULARS A B C
QTY SOLD UNIT 10000 10000 10000
SALE PRICE (PER UNIT) RS./UNIT 10 10 10
VARIABLE COST (PER UNIT) RS./UNIT 7 6 4
ANNUAL FIXED COST RS. 20000 30000 50000

CAPITAL STRUCTURE
EQ. SHARE OF RS.1 EACH RS. 50000 25000 10000
LOAN AT 10% RS. 0 25000 40000
TAX RATE 30% 30% 30%

CALCULATE PBIT AND EPS.

ASSUMING SALES INCREASE TO 11000 UNITS, CALCULATE REVISED PBIT, EPS &
DOL,DFL & DTL
PROFITABILITY UNDER DIFFERENT COST STRUCTURES
PARTICULARS RS. RS. RS.

REVENUE 100000 100000 100000

VARIABLE COST 70000 60000 40000

CONTRIBUTION 30000 40000 60000

FIXED COST 20000 30000 50000

PBIT/OPERATING PROFIT 10000 10000 10000

INTEREST 0 2500 4000

PBT 10000 7500 6000

TAX 3000 2250 1800

PAT 7000 5250 4200

EPS 0.14 0.21 0.42

PROFITABILITY UNDER DIFFERENT COST STRUCTURES

PARTICULARS RS. RS. RS.

REVENUE 110000 110000 110000
VARIABLE COST 77000 66000 44000
CONTRIBUTION 33000 44000 66000
FIXED COST 20000 30000 50000
PBIT/OPERATING PROFIT 13000 14000 16000
INTEREST 0 2500 4000
PBT 13000 11500 12000
TAX 3900 3450 3600
PAT 9100 8050 8400
EPS 0.182 0.322 0.84
 LEVERAGES
DOL
%AGE CHANGE IN PBIT 30% 40% 60%
%AGE CHANGE IN SALES VOLUME 10% 10% 10%
DOL TIMES 3.00 4.00 6.00

CONTRIBUTION AT BASE LEVEL 30000 40000 60000

PBIT AT BASE LEVEL 10000 10000 10000
DOL TIMES 3.00 4.00 6.00

DFL
%AGE CHANGE IN EPS 30% 53% 100%
%AGE CHANGE IN EBIT 30% 40% 60%
DFL TIMES 1.00 1.33 1.67

PBIT AT BASE LEVEL 10000 10000 10000

PBIT - I - (PREF. DIV/1-TAX) AT THE BASE LEVEL 10000 7500 6000
1.00 1.33 1.67
TOTAL LEVERAGE / COMBINED LEVERAGE
• DTL = DOL * DFL
• = % CHANGE IN PBIT * % CHANGE IN EPS
---------------------------- --------------------------
% CHANGE IN VOLUME % CHANGE IN PBIT

% CHANGE IN EPS
-------------------------------
% CHANGE IN VOLUME
 TOTAL LEVERAGE
• PBIT= Q(P-V)-F
• PAT = (PBIT-I)(1-T)
• EPS = (PBIT-I)(1-T)-Dp
------------------------
N
= [Q(P-V)-F-I](1-T)-Dp
------------------------------
N
 LEVERAGES

A B C

DOL TIMES 3.00 4.00 6.00

DFL TIMES 1.00 1.33 1.67

DTL OR DCL 3.00 5.33 10.00

 LEVERAGE AND RISK
• RISK BECAUSE OF FIXED COMPONENTS AND FIRMS
INABILITY TO MEET THESE COSTS IN CASE OF LOW
VOLUMES
• HIGH DEGREE OF VARIABILITY IN REACTION TO A
SMALL CHANGE IN VOLUME
• THUS, IF OPERATING LEVERAGE IS HIGH, FIRM
SHOULD CHOOSE A CAPITAL STRUCTURE WITH HIGH
EQUITY COMPONENT AND LOW DEBT/PREFERENCE
CAPITAL
• ON THE OTHER HAND, IF OPERATING LEVERAGE IS
STABLE FOR EXAMPLE A UTILITY CO., IT CAN BENEFIT
BY HIGHER FINANCIAL LEVERAGE OR DEBT IN ITS
CAPITAL STRUCTURE.
 PBIT – EPS ANALYSIS
• IN OUR SEARCH FOR OPTIMUM CAPITAL STRUCTURE, WE
NEED TO UNDERSTAND HOW SENSITIVE IS EPS TO
CHANGES IN PBIT, UNDER DIFFERENT FINANCING
ALTERNATIVES.
• LET US CONSIDER THE FOLLOWING CASE:
• EXISTING CAPITAL – 1 MILLION EQ. SHARES OF RS. 10EACH
• TAX RATE 50%
• FALCON PLANS TO RAISE ADDITIONAL CAPITAL OF RS. 10
MILLION FOR EXPANSION IT HAS 2 OPTIONS:1. ISSUE EQ.
SHARES – 1 MILLION SHARES AT RS. 10 EACH. 2). ISSUE
DEBENTURES CARRYING 14% INTEREST
• WHAT WILL BE THE EPS UNDER THE 2 ALTERNATIVE
FINANCING PLANS FOR 2 LEVELS OF PBIT, SAY RS. 4
MILLION AND RS. 2 MILLION.
EPS UNDER ALTERNATIVE FINANCING PLANS

PARTICULARS EQUITY FINANCING DEBT FINANCING

PBIT 20,00,000 40,00,000 20,00,000 40,00,000

INTEREST 0 0 14,00,000 14,00,000
PBT 20,00,000 40,00,000 6,00,000 26,00,000
TAXES 50% 10,00,000 20,00,000 3,00,000 13,00,000
PAT 10,00,000 20,00,000 3,00,000 13,00,000
NO. OF EQ. SHARES 20,00,000 20,00,000 10,00,000 10,00,000
EPS (RS.) 0.50 1.00 0.30 1.30
 BREAK-EVEN PBIT LEVEL
• THE BREAK-EVEN PBIT FOR TWO ALTERNATIVE FINANCING PLANS IS THE
LEVEL OF PBIT FOR WHICH EPS IS THE SAME UNDER BOTH THE
FINANCING PLANS.
• IT CAN BE GRAPHICALLY PLOTTED USING THE PBIT & EPS FOR BOTH THE
ALTERNATIVES AND NOTING THE POINT OF INTERSECTION.
• BREAK-EVEN LEVEL IS RS. 2.8 MILLION
• MATHEMATICALLY CAN BE CALCULATED USING THE FORMULA
• (PBIT-I)*(1-t) = (PBIT-I)*(1-t)
------------------ ------------------
n1 n2
(PBIT-0)*0.5 = (PBIT-1400000)*0.5
----------------- --------------------------
2000000 1000000
0.5PBIT*1000000 = 0.5PBIT*2000000-0.5*1400000*2000000
50000PBIT = 0.5*1400000*2000000
PBIT = 2,800,000
 RELATIONSHIP BETWEEN ROI AND ROE
• CAPITAL STRUCTURE
EQ 100 50
D 0 50
INTEREST 12%, TAX 50%
ROI = PBIT/INVESTMENT
ROE = PAT/NET WORTH
IF ROI IS 5%, 10%, 15%, 20%, 25%
PBIT 5 10 15 20 25 5 10 15 20
INTT 0 0 0 0 0 5 5 5 5
PBT 5 10 15 20 25 0 5 10 15
TAX 2.5 5 7.5 10 12.5 0 2.5 5 7.5
PAT 2.5 5 7.5 10 12.5 0 2.5 5 7.5
ROE 2.5% 5% 7.5% 10% 12.5% 0 5% 10% 15%
RATIO ANALYSIS
CONCLUSION

THANK YOU