EXAMPLE


The following information is available for ABC & Co.

EBIT                            Rs. 11,20,000
Profit before Tax         Rs. 3,20,000
Fixed costs                   Rs. 7,00,000

Calculate % change in EPS if the sales are expected to increase by 5%.

SOL:
 
In order to find out the % change in EPS as a result of% change in sales, the combined leverage should be calculated as follows:

          Operating Leverage  =  Contribution / EBIT
                                           =  Rs. 11,20,000 + Rs. 7,00,000 /  Rs.11,20,000
                                           = 1.625
         Financial Leverage   =  EBIT / Profit before tax
                                          =  Rs.11,20,000 / 3,20,000
                                          = 3.5
        Combined Leverage  = Contribution / Profit before tax = OL × FL
                                           = 1.625 × 3.5

The combined leverage of 5.69 implies that for 1% change in sales level, the % change in EPS would  be 5.69%. So, if the sales are expected to increase by 5% then the increase in EPS would be     5 × 5.69  = 28.45