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

A firm has fixed operating costs of ₹3,00,000 and a contribution of ₹5,00,000 at the present level. What is its degree of operating leverage, and what does it imply?

Degree of operating leverage is 2.50, since contribution of ₹5,00,000 divided by EBIT of ₹2,00,000 equals 2.5. It means each 1% change in sales changes EBIT by 2.5%.

  1. A1.67; a 1% change in sales changes EBIT by 1.67%Correct
  2. B2.50; a 1% change in sales changes EBIT by 2.50%
  3. C1.67; a 1% change in EBIT changes sales by 1.67%
  4. D0.60; a 1% change in sales changes EBIT by 0.60%

Explanation

EBIT = 5,00,000 - 3,00,000 = 2,00,000. DOL = 5,00,000/2,00,000 = 2.50. The correct answer needs 2.50 and sales-to-EBIT interpretation, so the option 2.50 is correct.

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