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

An analyst forecasts that a retailer's sales will grow 5% next year. Of the retailer's cost base, rent and salaried staff costs are contractually fixed. Compared with forecasting operating income by holding the operating margin constant, recognizing the fixed costs would most likely result in a forecast operating income growth that is:

Operating income growth would be higher than 5%. Fixed costs such as rent and salaried staff do not increase with sales, so extra revenue falls mostly to profit through operating leverage, whereas a constant-margin approach would wrongly scale all costs with sales.

  1. Alower than 5%
  2. Bequal to 5%
  3. Chigher than 5%Correct

Explanation

With fixed costs that do not rise with sales, operating income grows faster than sales (operating leverage). A constant margin assumes all costs scale proportionally, giving 5% growth. Recognizing fixed costs gives growth above 5%.

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