Which of the following is the correct interpretation of a degree of operating leverage of 5?
A) Operating leverage of 5 means that sales can decrease by 5% before the firm's current level of sales will hit the break-even point.
B) Operating leverage of 5 means that if sales increase by 5% the firm will hit its break-even point.
C) Operating leverage of 5 means that if sales increase by 5%, there will be a 25% increase in the firm's pretax profit.
D) Operating leverage of 5 measures the degree of debt employed by the firm's debt structure.
E) Operating leverage of 5 means that the company would need to increase sales by 5 times in order to hit its break-even point.

Question

Quizplus · Accepted Answer

Operating leverage of 5 means that a 5% increase in sales will result in a 25% increase in the firm's pretax profit. This is because operating leverage measures the degree to which a company uses fixed costs in its operations. A high degree of operating leverage means that a small increase in sales can result in a significant increase in profits, while a small decrease in sales can result in a significant decrease in profits. In this case, a degree of operating leverage of 5 means that a 5% increase in sales will result in a 25% increase in profits (5 x 5 = 25).

Which of the Following Is the Correct Interpretation of a Degree