degree of operating leverage

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ABC company currently has $ 2 million in sales. it's variable costs equal 70%of it sale , it's fixed cost are $100000 and its annual interest expenses is $50000.

(1) what is ABC company degree of operating leverage?

(2) If ABC company operating income (EBIT) rise by 10%,how much will its net income increase?

(3) If the company sale increase 10%,how much will the company net income increase?

1 Answer

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  • 7 years ago
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    Operating Leverage =[Quantity x (Price - Variable Cost per unit)] / [Quantity x (Price - Variable Cost per Unit) - Fixed Operating Cost].

    or = Sales$ X (1 - variable cost%) / [Sales$ X (1 - variable cost%) - $ fixed cost]

    (1) ABC company's degree of operating leverage:

    = $2,000,000 X 30% / ($2,000,000 X 30% - $100,000)

    = $600,00 / $500,000

    = 1.2 or 120%

    meaning: 10% increase in Sales Revenue will result in 12% increase in operating income.

    (2)

    Ratio of EBIT to Net Income

    = $500,000 / ($500,000 - $50,000)

    = $500,000 / $450,000

    = 1.11 or 111%

    If EBIT rises by 10%, Net income will rise by 10% X 1.11 = 11.1%

    (3)

    Ratio of Sales to Net Income

    = Operating Leverage X Ratio of EBIT to Net Income

    = 1.20 X 1.11

    = 1.32 or 132%

    if Sales increases by 10%, net income will increase by 13.2%

    Source(s): My past Learning
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