Question

Barcelona, Tbk. produce international quality soccer shoes. The price of a pair of soccer shoes is Rp. 250,000.00. The variable cost to produce soccer shoes is Rp. 150,000.00 and a fixed cost of Rp. 500,000,000.

a. It is assumed the company currently sells 6,000 pairs of soccer shoes per year, calculating operating leverage.

b. Based on problem (b) it is assumed the company has a total financial cost of Rp. 20,000,000, consisting of 40% interest expense and the remaining preferred stock dividends. The applicable tax rate is 40%, calculate the company's financial leverage.

c. Calculate the total leverage of the company.

Answer 1

The price of a pair of shoes 250,000 Rp

Variable cost to produce a pair of shoes 150,000 Rp

Fixed cost 500,000 Rp

The company sells 6,000 pairs of shoes.

So, the total sales = 250,000*6,000

= 1,500,000,000

Total Variable cost = 150,000*6,000

  = 900,000,000

a) Operating leverage

It is the degree to which a company can increase operating income by increasing revenue.

Operating leverage = Contribution margin/ Net operating income

Contribution Margin = Sales- Variable expenses

= 1,500,000,000- 900,000,000

= 600,000,000

Net operating income = Revenue- variable expenses- fixed expenses

  = 1,500,000,000- 900,000,000- 500,000

= 599,500,000  

Operating Leverage = 600,000,000 / 599,500,000

= 1.001

b) Financial Leverage

It is the policy of using more debt for funding the business in order to increase the return on investment.

Financial leverage = EBIT/ EBIT-I (Earning before interest and tax/ (Earning before interest and tax- Interest)

EBIT is the Net operating income = 599,500,000

Interest is 40% of the financial cost = 20,000,000*40%

= 8,000,000

Financial Leverage = 599,500,000 / ( 599,500,000 - 8,000,000)

= 1.014

c) Total Leverage

It is the combined effect of both operating and financial leverages

Total Leverage = Degree of operating leverage* Degree of financial leverage

  = 1.001 * 1.014

= 1.014