Question

If a company has sales of 11,880,000, fixed costs of 1,820,000 and a variable costs of 6,030,000, what is its degree of operating leverage?

Answer 1

The degree of operating leverage for the company is undefined because both the % change in operating income and the % change in sales are infinite.

Step-by-step explanation:

The degree of operating leverage (DOL) measures how sensitive a company's operating income is to changes in its sales revenue. It can be calculated by dividing the percentage change in operating income by the percentage change in sales revenue. The formula for DOL is:

DOL = % Change in Operating Income / % Change in Sales

Using the given information:

Sales = $11,880,000
Fixed Costs = $1,820,000
Variable Costs = $6,030,000

1. Calculate the Contribution Margin (CM):
   CM = Sales - Variable Costs
   CM = $11,880,000 - $6,030,000
   CM = $5,850,000
2. Calculate the Operating Income (OI):
   OI = CM - Fixed Costs
   OI = $5,850,000 - $1,820,000
   OI = $4,030,000
3. Calculate the % Change in Operating Income:
   % Change in OI = (OI - OI0) / OI0 * 100
   Assuming OI0 = 0 (initial operating income), % Change in OI = (4,030,000 - 0) / 0 * 100
   % Change in OI = Infinity
4. Calculate the % Change in Sales:
   % Change in Sales = (Sales - Sales0) / Sales0 * 100
   Assuming Sales0 = 0 (initial sales), % Change in Sales = (11,880,000 - 0) / 0 * 100
   % Change in Sales = Infinity
5. Compute the Degree of Operating Leverage:
   DOL = % Change in OI / % Change in Sales
   DOL = Infinity / Infinity
   DOL = Undefined

Based on the calculations, the degree of operating leverage for the company is undefined because both the % change in operating income and the % change in sales are infinite.