If a company has a degree of operating leverage of 3.0 and sales increase by 25%, then:
A)total variable costs will increase by 75%
B)total variable costs will not change
C)profit will increase by 30%
D)profit will increase by 75%

Question

Quizplus · Accepted Answer

The degree of operating leverage (DOL) is defined as the percentage change in profits for a percentage change in sales. DOL can be calculated as follows:

DOL = % change in profit / % change in sales

Given DOL = 3.0 and % change in sales = 25%, we can calculate the % change in profit as follows:

DOL = % change in profit / % change in sales
3.0 = % change in profit / 25%
% change in profit = 3.0 x 25%
% change in profit = 75%

This means that if the sales increase by 25%, the profit will increase by 75%. Therefore, the correct answer is D.

Option A is incorrect because total variable costs do not necessarily increase by the same percentage as sales.

Option B is incorrect because if sales increase, variable costs will also increase in proportion to the increase in sales.

Option C is incorrect because profit will increase by a higher percentage than the increase in sales due to the leverage effect.

If a Company Has a Degree of Operating Leverage of 3.0