If the degree of accounting operating leverage is 1.3 for a firm, then a 10 percent increase in revenue should drive a:
A) 12% increase in pretax operating cash flows.
B) 13% increase in EBIT.
C) 30% increase in EBIT.
D) 1.3% increase in pretax operating cash flows.

Question

Quizplus · Accepted Answer

The degree of operating leverage (DOL) is the ratio of the percentage change in EBIT to the percentage change in revenue.

DOL = (% change in EBIT) / (% change in revenue)

Given that DOL = 1.3 and the revenue increases by 10%, we can calculate the increase in EBIT using the following formula.

% change in EBIT = DOL x % change in revenue
% change in EBIT = 1.3 x 10% = 13%

Therefore, a 10% increase in revenue should drive a 13% increase in EBIT. This means that choice B is the correct answer.

If the Degree of Accounting Operating Leverage Is 1