Question

Company A is a manufacturer with current sales of $3,400,000 and a 60% contribution margin. Its fixed costs equal $1,600,000. Company B is a consulting firm with current service revenues of $3,500,000 and a 25% contribution margin. Its fixed costs equal $410,000. Compute the degree of operating leverage (DOL) for each company.

Answer 1

Answer:

DOL of Company A= 4.63

DOL of Company B =1.88

Explanation:

The degree of operating leverage measures the volatility in the operating profit of a business as result of the proportion of fixed cost to its total costs.

The operating Leverage = Contribution margin/Operating income

Contribution margin= 60%× 3,400,000 = 2,040,000

Operating income =  60%× 3,400,000 - 1,600,000= 440,000

DOL =2,040,000 /440,000 = 4.634

DOL of Company A= 4.63

Company B

Contribution margin= 25%×  3,500,000=875000

Operating income = 875000  - 410,000 =465000

DOL = 875,000 /465,000  × 100 =1.88

DOL=1.88