Zenith Manufacturing Ltd., a mid-sized production company, is currently reviewing the impact of its capital structure on profitability and risk. The…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2026
Zenith Manufacturing Ltd., a mid-sized production company, is currently reviewing the impact of its capital structure on profitability and risk. The company has financed its operations through a mix of equity and debt. The capital structure of Zenith Manufacturing Ltd. consists of: Equity share capital of 15,00,000 (shares of 100 each), and 10% debentures amounting to 15,00,000. During the current financial year, the company experienced a 20% increase in sales volume, rising from 1,50,000 units to 1,80,000 units. The management is interested in understanding how this increase in activity level affects earnings and leverage. The selling price is 15 per unit, variable costs amount to 8 per unit and fixed expenses amount to 3,00,000. The income tax rate is assumed to be 30 per cent. (I) You are required to CALCULATE the following: (i) The percentage increase in earnings per share. (ii) The degree of financial leverage at 1,50,000 units and 1,80,000 units. (iii) The degree of operating leverage at 1,50,000 units and 1,80,000 units. (II) COMMENT on the behaviour of operating and financial leverage in relation to increase of production from 1,50,000 to 1,80,000 units.

Suggested Answer and Working Notes:

(I) Determination of earnings per share (EPS) Sales Level 1,50,000 Units 1,80,000 Units (₹) (₹) Sales Revenue 22,50,000 27,00,000 Variable Cost 12,00,000 14,40,000 Contribution 10,50,000 12,60,000 Fixed Cost 3,00,000 3,00,000 EBIT 7,50,000 9,60,000 Interest 1,50,000 1,50,000 EBT 6,00,000 8,10,000 Tax (30%) 1,80,000 2,43,000 EAT 4,20,000 5,67,000 No. of Shares 15,000 15,000 EPS (₹) 28.00 37.80 (i) The percentage increase in earnings per share = (37.8 - 28) / 28 × 100 = 35% (ii) DFL at 1,50,000 units = EBIT / EBT = 7,50,000 /6,00,000 = 1.25 DFL at 1,80,000 units = EBIT / EBT = 9,60,000 /8,10,000 = 1.19 (iii) DOL at 1,50,000 units = Contribution / EBIT = 10,50,000 /7,50,000 = 1.40 DOL at 1,80,000 units = Contribution / EBIT = 12,60,000 /9,60,000 = 1.31 (II) With the increase in production and sales from 1,50,000 units to 1,80,000 units, the EPS has increased by 35%, indicating improved profitability. Further, both operating leverage and financial leverage have decreased, which implies: Reduction in business risk (due to lower operating leverage), andReduction in financial risk (due to lower financial leverage). Hence, the overall risk profile of the company declines with an increase in of production from 1,50,000 to 1,80,000 units.

Topics: Part-A: Financial Management

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