The degree of operating leverage for ABC Inc.is 3.5,and the degree of operating leverage for XYZ Corporation is 7.0.According to this information,which firm is considered to have greater business risk?
A) ABC Inc.
B) XYZ Corporation.
C) The degree of operating leverage is not a measure of business risk,so it is not possible to tell which firm has the greater business risk given the above information.
D) To determine which firm has the greater business risk,we need to know the operating income (NOI or EBIT)of each firm.XYZ Corporation would have less business risk if its operating income is at least twice that of ABC Inc.
E) None of the above is a correct answer.

Question

Quizplus · Accepted Answer

The degree of operating leverage (DOL) measures the sensitivity of operating income (EBIT) to changes in sales. A higher DOL means that operating income will change more for the same change in sales. Therefore, a higher DOL indicates a greater business risk. As XYZ Corporation has a higher DOL than ABC Inc., it implies that XYZ Corporation has greater business risk. Option A is incorrect because ABC Inc. has a lower DOL, indicating lower business risk. Option C is incorrect because DOL is a measure of business risk. Option D is incorrect because the operating income of each firm is not relevant to determining the DOL and business risk. Option E is incorrect because option B is the correct choice.

The Degree of Operating Leverage for ABC Inc