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

Tanvi Plastics has sales of Rs 12,00,000 and a break-even sales of Rs 9,00,000. What is its degree of operating leverage?

The DOL is 4. The margin of safety is Rs 3,00,000, or 25% of sales, and DOL equals the reciprocal of the margin of safety ratio, so 1/0.25 = 4. This agrees with contribution of Rs 4,80,000 divided by EBIT of Rs 1,20,000.

  1. A1.33
  2. B3.00
  3. C4.00Correct
  4. D0.25

Explanation

Margin of safety = 12,00,000 - 9,00,000 = Rs 3,00,000, which is 25% of sales. DOL = 1/margin of safety ratio = 1/0.25 = 4. Check: if the P/V ratio is 40%, contribution is 4,80,000, fixed cost is 3,60,000 (9,00,000 x 40%), EBIT is 1,20,000 and DOL = 4,80,000/1,20,000 = 4. The value 1.33 is Sales/BEP sales, which is not DOL.

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