Question

"Company A is a manufacturer with current sales of $3,700,000 and a 60% contribution margin. Its fixed costs equal $1,810,000. Company B is a consulting firm with current service revenues of $3,800,000 and a 20% contribution margin. Its fixed costs equal $330,000. Compute the degree of operating leverage (DOL) for each company"

Answer 1

Answer: Company A - 5.41

Company B - 1.77

Explanation:

The Degree of operating leverage (DOL) is measure that can tell what happens to operating income if sales change.

It is calculated by dividing the Contribution Margin by the net income.

Contribution Margin can be defined as the selling price of a good minus the variable costs of the good. Therefore when you see Contribution Margin, the variable costs have been removed already.

DOL Company A

Net Income = Contribution Margin - Fixed Costs

Net Income = (60%* 3,700,000 ) - 1,810,000

Net Income = 2,220,000 - 1,810,000

= $410,000

Degree of Operating Level = Contribution Margin/Net Income

= 2,220,000/410,000

= 5.41

DOL Company B

Net Income = Contribution Margin - Fixed Costs

Net Income = (20%* 3,800,000 ) - 330,000

Net Income = 760,000 - 330,000

= $430,000

Degree of Operating Level = Contribution Margin/Net Income

= 760,000/430,000

= 1.77