leverage- classcase

The Devyani Garments Limited is a leading manufacturer
of readymade
garments. For the year ending 30 June, 2007 the
company earned a
profit of Rs. 59,500 on sales of Rs. 7,50,000.

For the year ending 30 June, 2008 the company expects
sales to be of
Rs. 8,00,000 without any increase in the fixed costs.
Variable costs
are expected to remain at the same proportion to
sales.

The company is further investigating the possibility
of entering into
two product lines. The estimated expenditure is
required to be
incurred for Product I and Product II, respectively is
Rs. 2,00,000
and Rs. 3,00,000. The annual anticipated sales of the
two Products are
Rs.1,50,000 and Rs. 2,50,000. The board of directors
envisages the
variable costs at two thirds the level of sales for
Product I and at
64% for Product II. Fixed overheads are expected to be
Rs. 20,000 and
Rs. 50,000 for Products I and II, respectively.

The company's Balance Sheet and the Profit and Loss
Account are given below:

Balance Sheet As at 30 June,2007

Liabilities Rs Assets Rs.

Equity share capital Fixed Assets 6,00,000
(10,000 shares of Rs. 10 each)
1,00,000
Reserves and surplus 4,20,000 Stocks 60,000

12% Secured debentures 2,00,000 Sundry debtors 70,000

Current Liabilities 50,000 Cash and bank 40,000

Total
7,70,000 Total 7,70,000

Profit and Loss Account
For the year ended 30 June, 2007

Particulars Rs.
Sales
7,50,000

Variable costs
4,69,000

Contribution
2,81,000

Fixed overheads
1,40,000

EBIT
1,41,000

Interest
24,000

Profit before tax(PBIT)
1,17,000

Taxes
58,500

Profit After Tax
58,500

Questions for discussion

1) Calculate the operating, financial and
combined
leverages of the Vastrapur Garments Limited for the
year ending
30 June, 2007 without taking into consideration
the new projects.
What effect does it have on the EPS?

2) How does the acceptance of each of the new
projects
affect the operating leverage and the margin of
safety?