For a firm with a DOL of 3.5, an increase in sales of 6 percent will:
A)increase pretax profits by 3.5 percent.
B)decrease pretax profits by 3.5 percent.
C)increase pretax profits by 21.0 percent.
D)increase pretax profits by 1.71 percent.

Question

Quizplus · Accepted Answer

Degree of Operating Leverage (DOL) is a measure of the sensitivity of a company's operating income to changes in its sales revenue.

DOL = percentage change in operating income / percentage change in sales

Here, DOL = 3.5

If there is an increase in sales of 6 percent, then the percentage change in sales = 6%, and the percentage change in operating income can be calculated as:

Percentage change in operating income = DOL x percentage change in sales
= 3.5 x 6%
= 21%

Therefore, an increase in sales of 6 percent will increase pretax profits by 21.0 percent. So, the best choice is option C.

For a Firm with a DOL of 3