Financial Leverage, earnings and

dividend
To maximize owners wealth the finance manager needs to pay
attention on investment, financing & dividend decision.
Investment Decision: decisions regarding allocation of limited
resources among different projects.
Financing Decisions: decisions regarding sources from where funds
can be raised for the firm.

Dividend Decisions: decisions regarding what amount out of the

earnings to be distributed as dividend among the shareholders and
what amount to be retained for the firms growth.

Financial Leverage
concerned with the financial activities involving raising funds
from sources for which the firm has to bear a fixed charge.
Includes long term debt like bonds, debentures.

Shows the effect of change in EBIT on EPS. It is calculated as

follows:
=

%
when change in the level of activity
%

Earnings Per Share

The reward for an investor for making
investment.
It is calculated as follows:
&
=
.

Dividend Per Share

The amount paid as dividend for each share issued.
It is calculated as follows:

=
.

Bharat Heavy Electricals Ltd. (BHEL)

Company Profile:
Paid-up capital Rs. 2448 million
Turnover of Rs. 66,340 million in 1999-2000
Investment on plan capital programs
Enhancing competitiveness by reducing time
& cost, improving quality & tapping new
opportunities in the environment.

Research Study
Objectives:

Study the methods of raising finance & financial leverage

practice of the company.

Examine the impact of financial leverage on EPS.

Know about the dividend policy of the company.

Assess the inter relationship between DFL, EPS and DPS.

Research Design and Methodology

Collection of Data: The data have been collected from the annual
reports of the company and compiled as per the requirement of the
study.

Period of study: 1993-1994 to 1999-2000

Technique of analysis: The data has been converted into relative
measures such as ratios & percentages rather than absolute one.
For analyzing the degree of association between DFL, EPS & DPS,
Pearsons correlation analysis has been applied.
The t test has been used judge whether the calculated correlation coefficient are significant or not.

Testing of Hypothesis
1. Company uses debt as a cheaper source of
finance than equity.
Year

DFL

EPS

DPS

DPR(%)

Interest(%)

Kd (%)

Ke (%)

Rate of return on
investment

1993-94

1.34

5.6

1.5

27

7.9

4.7

3.6

5.7

1994-95

1.28

5.8

1.5

26

9.6

5.8

3.2

6.3

1995-96

1.19

14.3

14

12.8

7.7

3.3

14.8

1996-97

1.18

18.9

2.2

12

18.4

11

2.8

16.6

1997-98

1.05

29.4

2.75

15.3

9.1

2.6

24.1

1998-99

1.03

22.3

2.77

12

18.6

11.2

2.2

16.7

1999-00

1.02

24.5

3.49

14

5.4

2.5

16.6

Result: Debt is not used as a cheaper source of finance by the company.

2. Company is enable to earn a higher rate of return

on investment than the cost of financing
investment.
Year

Total Capital
Employed

Long term
debt

Equity share
capital

EAT

1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00

23941
22304
23707
27888
29846
32526
35985

13839
10760
8822
8640
3896
1701
2407

2448
2448
2448
2448
2448
2448
2448

1369
1409
3502
4632
7195
5446
5994

Year

DFL

EPS

DPS

DPR(%)

Interest(%)

Kd (%)

Ke (%)

Rate of return on
investment

Cost of capital

1993-94

1.34

5.6

1.5

27

7.9

4.7

3.6

5.7

4.5

1994-95

1.28

5.8

1.5

26

9.6

5.8

3.2

6.3

5.3

1995-96

1.19

14.3

14

12.8

7.7

3.3

14.8

6.7

1996-97

1.18

18.9

2.2

12

18.4

11

2.8

16.6

9.2

1997-98

1.05

29.4

2.75

15.3

9.1

2.6

24.1

6.6

1998-99

1.03

22.3

2.77

12

18.6

11.2

2.2

16.7

5.9

1999-00

1.02

24.5

3.49

14

5.4

2.5

16.6

3.9

Result: Rate of return on investment is greater than the cost of financing investment.

3. DFL & EPS are positively correlated.

Year

DFL

EPS

DPS

DPR(%)

Interest(%)

1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00

1.34
1.28
1.19
1.18
1.05
1.03
1.02

5.6
5.8
14.3
18.9
29.4
22.3
24.5

1.5
1.5
2
2.2
2.75
2.77
3.49

27
26
14
12
9
12
14

7.9
9.6
12.8
18.4
15.3
18.6
9

Correlation between DFL & EPS

Year

Total Capital Long term Equity share Reserves &

Net worth
Employed
debt
capital
surplus

-0.94

EBIT

Interest

EBT

Dividend

EAT

1993-94

23941

13839

2448

7654

10102

4269

1096

3173

367

1369

1994-95

22304

10760

2448

9096

11544

4690

1039

3651

367

1409

1995-96

23707

8822

2448

12437

14885

6952

1129

5823

490

3502

1996-97

27888

8640

2448

16800

19248

10235

1591

8644

539

4632

1997-98

29846

3896

2448

23502

25950

10813

596

10217

673

7195

1998-99

32526

1701

2448

28377

30825

9640

317

9323

679

5446

1999-00

35985

2407

2448

31130

33578

8871

217

8654

853

5994

Result: DFL & EPS are negatively correlated.

4. DFL is positively correlated with DPS.

Year

DFL

EPS

DPS

DPR(%)

Interest(%)

1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00

1.34
1.28
1.19
1.18
1.05
1.03
1.02

5.6
5.8
14.3
18.9
29.4
22.3
24.5

1.5
1.5
2
2.2
2.75
2.77
3.49

27
26
14
12
9
12
14

7.9
9.6
12.8
18.4
15.3
18.6
9

Correlation between DFL & DPS

Year

Total Capital Long term Equity share Reserves &

Net worth
Employed
debt
capital
surplus

-0.95

EBIT

Interest

EBT

Dividend

EAT

1993-94

23941

13839

2448

7654

10102

4269

1096

3173

367

1369

1994-95

22304

10760

2448

9096

11544

4690

1039

3651

367

1409

1995-96

23707

8822

2448

12437

14885

6952

1129

5823

490

3502

1996-97

27888

8640

2448

16800

19248

10235

1591

8644

539

4632

1997-98

29846

3896

2448

23502

25950

10813

596

10217

673

7195

1998-99

32526

1701

2448

28377

30825

9640

317

9323

679

5446

1999-00

35985

2407

2448

31130

33578

8871

217

8654

853

5994

Result: DFL & DPS are negatively correlated.

5. EPS is positively correlated with DPS.

Year

DFL

EPS

DPS

DPR(%)

Interest(%)

1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00

1.34
1.28
1.19
1.18
1.05
1.03
1.02

5.6
5.8
14.3
18.9
29.4
22.3
24.5

1.5
1.5
2
2.2
2.75
2.77
3.49

27
26
14
12
9
12
14

7.9
9.6
12.8
18.4
15.3
18.6
9

Correlation between EPS & DPS

Year

Total Capital Long term Equity share Reserves &

Net worth
Employed
debt
capital
surplus

0.89

EBIT

Interest

EBT

Dividend

EAT

1993-94

23941

13839

2448

7654

10102

4269

1096

3173

367

1369

1994-95

22304

10760

2448

9096

11544

4690

1039

3651

367

1409

1995-96

23707

8822

2448

12437

14885

6952

1129

5823

490

3502

1996-97

27888

8640

2448

16800

19248

10235

1591

8644

539

4632

1997-98

29846

3896

2448

23502

25950

10813

596

10217

673

7195

1998-99

32526

1701

2448

28377

30825

9640

317

9323

679

5446

1999-00

35985

2407

2448

31130

33578

8871

217

8654

853

5994

Result: EPS & DPS are positively correlated.