ABC Industries is a mid-sized company manufacturing consumer goods. Last quarter, the company reported sales of 2,00,000. The production process…

CA Intermediate · Financial Management and Strategic Management · MTP · January 2025
ABC Industries is a mid-sized company manufacturing consumer goods. Last quarter, the company reported sales of 2,00,000. The production process involves significant variable costs, which account for 50% of the sales value. Additionally, the company incurs - 40,000 as fixed operating costs for rent, utilities, and management expenses. ABC Industries has also borrowed funds, leading to 10,000 as annual interest on long-term debt. The company is currently planning to launch a new marketing campaign aimed at boosting sales by 10%. As a financial analyst at ABC Industries, you are required to: CALCULATE the combined leverage.ILLUSTRATE the impact of the 10% sales increase using the combined leverage.

Suggested Answer and Working Notes:

Statement showing Computation of Combined leverage Particulars ₹ Sales 2,00,000 Less: Variable costs (50%) 1,00,000 Contribution 1,00,000 Less: Fixed operating costs 40,000 EBIT 60,000 Less: Interest 10,000 Taxable Income (PBT) 50,000 Combined leverage = C / PBT = 1,00,000 / 50,000 = 2 The combined leverage of '2' indicates that with every increase of 1in sales, the taxable income will increase by - 2 (i.e. 1×2). This can be verified by the following computations when the sales increase by 10% Particulars ₹ Sales 2,20,000 Less: variable costs (50%) 1,10,000 Contribution 1,10,000 Less: Fixed operating costs 40,000 EBIT 70,000 Less: Interest 10,000 Taxable Income (PBT) 60,000 It is clear from the above computation that on account of increase in sales by 10%, the profit before tax has increased by 20%.

Topics: Part-A: Financial Management

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