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CFA Level I · CFA Level I Exam · Financial Statement Forecasting in Equity Valuation

A firm has sales of 500, variable costs of 300 and fixed costs of 100, so operating income is 100. The analyst forecasts sales rising 8% with the same variable cost ratio and unchanged fixed costs. Forecast operating income is closest to:

Forecast operating income is about 116. Sales of 540 less variable costs of 324 (60% of sales) and fixed costs of 100 leaves 116. Equivalent to a degree of operating leverage of 2 magnifying 8% sales growth into 16% income growth.

  1. A108
  2. B116Correct
  3. C120

Explanation

New sales = 540. Variable costs = 60% x 540 = 324. Fixed = 100. Operating income = 540 - 324 - 100 = 116. Check: DOL = 200/100 = 2; 2 x 8% = 16% rise, 100 x 1.16 = 116. The 108 option applies 8% growth to income, ignoring leverage.

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