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CA Intermediate · Financial Management and Strategic Management · Financing Decisions - Leverages

A firm has a degree of operating leverage (DOL) of 3 at its current sales level. If sales increase by 8% and the cost structure remains unchanged, by what percentage will EBIT increase?

EBIT will rise by 24%. Degree of operating leverage measures the percentage change in EBIT for each one percent change in sales, so multiplying the DOL of 3 by the 8% sales increase gives a 24% increase in operating profit.

  1. A11%
  2. B24%Correct
  3. C2.67%
  4. D8%

Explanation

DOL = % change in EBIT / % change in sales, so % change in EBIT = 3 × 8% = 24%. Adding 3 to 8 (11%) confuses addition with multiplication. Dividing 8 by 3 (2.67%) inverts the formula.

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