Question

Impact of Increased Sales on Operating Income Using the Degree of Operating Leverage Chillmax Company had planned to sell 3,500 pairs of shoes at $60 each in the coming year. Unit variable cost is $21 (includes direct materials, direct labor, variable factory overhead, and variable selling expense). Total fixed cost equals $78,000 (includes fixed factory overhead and fixed selling and administrative expense). Operating income at 3,500 units sold is $58,500. The degree of operating leverage is 2.3. Now Chillmax expects to increase sales by 10% next year.

Required:
1. Calculate the percent change in operating income expected.
_______%
2. Calculate the operating income expected next year using the percent change in operating income calculated in Requirement 1.

Answer 1

1. Degree of Operating Level = %Δ in EBIT / %Δ in sales

2.3 = %Δ in EBIT / 10

%Δ in EBIT = 2.3*10

%Δ in EBIT = 23

Hence, the percentage change in EBIT is 23%

2. Operating Income Expected = Operating Income * (1+%Δ in EBIT)

Operating Income Expected = $58,500 *(1+23%)

Operating Income Expected = $58,500 *1.23

Operating Income Expected = $71,955