Stromburg Corporation makes surveillance equipment for intelligence organizations.Its sales are $75,000,000.Fixed costs,including research and development,are $40,000,000,while variable costs amount to 30% of sales.Stromburg plans an expansion which will generate additional fixed costs of $15,000,000,decrease variable costs to 25% of sales,and also permit sales to increase to $98,000,000.What is Stromburg's degree of operating leverage at the new projected sales level?
A) 3.8141
B) 4.4100
C) 3.9730
D) 3.0989
E) 4.0127

Question

Quizplus · Accepted Answer

Degree of Operating Leverage (DOL) = Contribution Margin / Operating Income

Contribution Margin = Sales - Variable Costs

Before the expansion:
Sales = $75,000,000
Variable Costs = 30% * $75,000,000 = $22,500,000
Fixed Costs = $40,000,000

Contribution Margin = $75,000,000 - $22,500,000 = $52,500,000
Operating Income = Contribution Margin - Fixed Costs = $52,500,000 - $40,000,000 = $12,500,000

DOL = $52,500,000 / $12,500,000 = 4.2

After the expansion:
Sales = $98,000,000
Variable Costs = 25% * $98,000,000 = $24,500,000
Fixed Costs = $40,000,000 + $15,000,000 = $55,000,000

Contribution Margin = $98,000,000 - $24,500,000 = $73,500,000
Operating Income = Contribution Margin - Fixed Costs = $73,500,000 - $55,000,000 = $18,500,000

DOL = $73,500,000 / $18,500,000 = 3.9730

Therefore, the best choice is C, with a DOL of 3.9730 at the new projected sales level.

Stromburg Corporation Makes Surveillance Equipment for Intelligence Organizations