Question

Degree of operating leverage should be computed only over a profitable range of operations. True False

Answer 1

The statement about the degree of operating leverage is false; DOL can be computed even when a company is not profitable, offering insights into how sales volume changes affect operating income.

Step-by-step explanation:

The statement that the degree of operating leverage should be computed only over a profitable range of operations is false. The degree of operating leverage (DOL) measures how a company's operating income changes in response to a change in sales. It is defined as the percentage change in operating income divided by the percentage change in sales. While it is important for a company to be profitable, the DOL can be computed and analyzed even when the company is not currently generating a profit. Understanding the DOL can help a company plan and predict the effects of changes in sales volume on profitability, and it is useful in scenarios of both profits and losses.

The concept of operating leverage is critical in understanding cost behavior and how it impacts a firm's earnings. A company with a higher DOL is more sensitive to changes in sales, which means that a small increase in sales can lead to a larger change in operating income. Conversely, a decrease in sales can result in a more significant decrease in operating income for a company with high operating leverage, indicating more risk during economic downturns.

Answer 2

The degree of operating leverage should indeed be computed only over a profitable range of operations because it measures the impact of fixed costs on profitability as sales volume changes.

Step-by-step explanation:

The statement that the degree of operating leverage should be computed only over a profitable range of operations is true. The concept of operating leverage relates to the proportion of fixed versus variable costs in a company's cost structure. It captures the effect that fixed costs have on the profitability of a company as sales volume changes. When a company is operating within a profitable range, it means that its revenues exceed its variable and fixed costs, which is necessary to calculate the operating leverage effect accurately. Conversely, if a company is operating at a loss, the degree of operating leverage may not provide meaningful insights because the primary concern would be the company's ability to cover its variable costs and operating expenses.