Page 94 - DMGT409Basic Financial Management

Unit 5: Capital Structure Decisions

13. Optimum leverage is that mix of debt & equity which will maximise the market value of Notes
the company.
14. Capital structure that allows the existing capital structure to change according to the

changing conditions without increasing the costs is called flexible capital structure.

15. The fixed charges vary with fi rm’s EBIT.
5.8 Review Questions

1. A firm has sales of ` 5 lakh, variable cost ` 3.5 lakh and fi xed cost ` 1 lakh, and debt of ` 2.5

lakh at 10 per cent.
2. The following data is available for X Ltd:

Selling price ` 120 pu; Variable cost ` 70 pu; Total fi xed cost ` 200,000
(a) What is the operating leverage when, X Ltd produces and sells 6000 units,

(b) What is the percentage change that will occurring in the operating profit (EBIT) of X
Ltd, if output increases by 5 per cent

3. Calculate operating and financial leverages under situations A, B and C and Financial
plan 1,2, and 3 respectively from the following functions of XYZ Co. Also find out the

combination of operating and financial leverage that gives the highest value and least

value:
Installed capacity = 12,000 units;
Actual production & sales = 800 units
Selling price = ` 15 p.u;
Variable cost = ` 10 p.u
Fixed Cost = Situation A, ` 1000; Situation B, ` 2000; Situation C, ` 3000

4. Define capital structure? Discuss the important factors that should be considered while
determining capital structure.
5. What is operating leverage? How does it help to maximize, revenue of a fi rm?
6. What is trading an equity? How does it maximize the equity earnings?

7. Distinguish between capital structure and fi nancial structure.
8. What basic principles will you advocate in the matter of deciding on a proper constitution
of capital structure for a fi rm?
9. Sales ` 1,00,000 units at ` 2 per unit, variable cost `0.70 per unit, fi xed cost `1, 00,000,

interest charges ` 3,668. Compute degree of operating leverage, financial leverage, and
combined leverage.
10. Distinguish between operating and fi nancial leverage.
Answers: Self Assessment

1. fi nancial structure 2. long-term
3. Optimum capital structure 4. leverage
5. Operating leverage 6. operating costs
7. Financial leverage 8. fi nancing activities

LOVELY PROFESSIONAL UNIVERSITY 87