ACME,Inc.reported the following income statement for 2009:

If ACME's sales next year increase by 20%,ACME's EBIT will increase
A) 20%, showing no operating leverage.
B) 20%, showing no financial leverage.
C) over 35%, due to operating leverage.
D) over 35%, due to operating leverage and financial leverage.

Question

ACME,Inc.reported the following income statement for 2009:

If ACME's sales next year increase by 20%,ACME's EBIT will increase
A) 20%, showing no operating leverage. 
B) 20%, showing no financial leverage. 
C) over 35%, due to operating leverage. 
D) over 35%, due to operating leverage and financial leverage.

Quizplus · Accepted Answer

Operating leverage refers to the degree to which a company's operating income or EBIT changes in response to a change in sales revenue. Since ACME's EBIT margin is 5%, a 20% increase in sales would result in a 100% increase in operating income or EBIT (20% x 5% = 100%). Therefore, ACME's EBIT would increase by over 35% due to operating leverage. There is no information given about financial leverage, so we cannot assume that it would also impact ACME's EBIT. Therefore, option C is the best choice as it only considers the impact of operating leverage.

ACME,Inc.reported the Following Income Statement for 2009