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 the percentage change in earnings before interest and taxes (EBIT) in response to a percentage change in sales. 
DOL = (percentage change in EBIT)/(percentage change in sales)
Here, DOL = 3.5
Percentage change in sales = 6%
Using the DOL formula, we can calculate the percentage change in EBIT:
3.5 = (percentage change in EBIT)/(0.06)
Percentage change in EBIT = 3.5 x 0.06 = 0.21 or 21%
So, an increase in sales of 6% will increase pretax profits by 21%. Therefore, the correct answer is C.

For a Firm with a DOL of 3