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

A firm's contribution is exactly equal to its fixed operating costs, and it has no interest. Which statement about its Degree of Operating Leverage is correct?

DOL is undefined because EBIT is zero. Contribution equals fixed operating costs, which is the operating break-even point, and dividing contribution by a zero EBIT is not possible. DOL becomes very large as sales approach this point.

  1. ADOL is zero because EBIT is zero
  2. BDOL is undefined because EBIT is zero, indicating the operating break-even pointCorrect
  3. CDOL is 1 because there is no financial leverage
  4. DDOL is infinite only if sales are zero

Explanation

If contribution equals fixed costs, EBIT = 0. DOL = Contribution/EBIT, so the denominator is zero and DOL is undefined (tends to infinity near this point). This is the operating break-even point. DOL of 1 occurs only when fixed costs are zero.

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