Formula for Calculating Combined Leverage

Combined/composite/total leverage measures the relationship between quantity produced and sold and EPS.

Thus, the degree of combined leverage (DCL) is computed as under:

Illustration:

Calculate the degree of operating leverage, degree of financial leverage and the degree of combined leverage for the following firms and interpret the result:

Solution:

Interpretation and Comments:

ADVERTISEMENTS:

From the above statements, the DOL reveals that if there is a variation in sales by 1%, there is a corresponding variation in EBIT by 2.4%, 2.14% and 1 6% in the case of firm B, Q and R respectively On the other hand, the DFL shows that if EBIT varies by 1% there will be a corresponding variation in EPS by 1.11%, 1.07% and 1% in the case of the firms B. O and R.

Similarly, DCL prove that if sales vary by 1%, there will be a corresponding variation in EBT by 2.67, 2.29 and 1.60 in the case of firm B, O and R respectively.

It is also found from the above table that firm B posses all the three highest leverage followed by Q and R. Moreover the DFL is lower than DOL in all the cases. Combined leverage measures the total risk of the firm. Thus, if the two leverages are high, no doubt, it is a very risky one.

Thus, if a firm enjoys low financial leverage and high operating leverage the same partly adjust the high operating leverage which has been found in the present problem. Because, we know that a low operating leverage presents lower fixed cost and higher variable cost.

ADVERTISEMENTS:

A high financial leverage indicates that the firm increase its ROE after applying debt-financing in its capital structure. So it can be concluded that a firm should always have a high financial leverage corresponding to a low operating leverage. If this is taken into consideration none of the said three firms have faithfully followed the norms.

, , ,


Related pages


reasons for bank reconciliationconstant payout ratio dividend policymachine hour rate calculation formulaspoilage in process costingdefine byproductexplain tax incidencebudgetary control techniquesdebtors turnover ratio formulamethods of absorption costingfinancial leverage percentage formulawhat is the difference between profit maximization and wealth maximizationthree column cash book pdfdistinguish between job costing and process costingare marketable securities a current assetdefinition of costing and cost accountingbill discounting wikipediadefine financial ratio analysiscapitalise meaningbreak even analysis formulasltf financeaccounting cvpbalance of payment equilibriumwhat is iasb conceptual frameworkadvantages and disadvantages of petty cash bookdegree of total leveragevaluation of goodwill and shares problemshca meansbenefits of target costingwip valuationhow to allot sharesequilibrium and disequilibrium in economicsoar formula accountingcost concepts accountingvariances in standard costingprocedure for preparing bank reconciliation statementtax incidence elasticitycash to accrual conversion worksheetprinciples of accountancymarginal utility diagramtrial balance definition in accountingdefinition disequilibriumadvantages of budgetary controlwhole life cycle costing examplemarketable securities examples balance sheetsubjectivnessbep in unitsorder of permanencedefinition of bill discountingmachine operator hourly ratehorizontal fiscal imbalancewhat are the different types of factoringledger and journal entriespromissory note format in hindidirect expenses and indirect expensesconservatism principlemoneys received basis of accountingplanning and operational variancesnormative theory in accountinglabour cost variancewhen to use absorption costingin break even analysis the contribution margin is defined asconvert accrual to cash basisinfosys technologies indiadifferent methods of inventory valuationdrawer drawee and payee in chequecreditor turnovergearing financecost allocation and apportionmentpro rata allotment of shareswhat is the meaning of lcchistorical cost convention accountingsales ledger accounterrors and suspense accountsbill of exchange specimenalternatives to historical cost accounting