If a company has a degree of operating leverage of 3.0 and sales increase by 25%,then ________.
A) total fixed costs will increase by 75%
B) total costs will increase by 75%
C) profit will increase by 30%
D) profit will increase by 75%

Question

Quizplus · Accepted Answer

Degree of operating leverage (DOL) is defined as the percentage change in net operating income (profit) resulting from a percentage change in sales.

DOL = % Change in Operating Income / % Change in Sales

Here, the DOL is given as 3.0, which means that for a 1% increase in sales, the operating income (profit) will increase by 3%.

Now, if the sales increase by 25%, then using the DOL formula, we can calculate the increase in operating income (profit) as:

% Change in Operating Income = DOL x % Change in Sales 
% Change in Operating Income = 3.0 x 25 
% Change in Operating Income = 75%

Therefore, the profit will increase by 75%. Hence, the correct answer is D.

Note: Total fixed costs and total costs are not affected by the change in sales, so options A and B are incorrect. Option C assumes that the variable costs remain constant, which may not be true in reality.

If a Company Has a Degree of Operating Leverage of 3.0