Question

Alpha Corporation reported the following data for its most recent year: sales, $530,000; variable expenses, $280,000; and fixed expenses, $200,000. The company's degree of operating leverage is closest to:

Answer 1

Answer:

5

Explanation:

In Operating Leverage, Leverage is our Fixed Cost. So Operation Leverage means that because of Fixed Cost what impacts will occur in Alpha Corporation's Business. So If the Sales increases, how much profit will increase, that is what we are going to find out using Operation Leverage.

Alpha Corporation

Income Statement

Sales $530,000

(-) Variable Expenses $280,000

Contribution $250,000

(-) Fixed Cost $200,000

Net Operating Income $50,000

Degree of Operating Leverage = Contribution / Net Operating Income

Degree of Operating Leverage = $250,000 / $50,000

Degree of Operating Leverage = 5

It means that if Alpha Corporation's Sales are going to increase by 10% then the Net Operating Income is going to increase by:

10% x 5 = 50%

Since the Sales and Variable Cost are directly proportional so if sales are going to increase by 10% then the Variable Cost will also increase by 10%. The Fixed Cost will remain the same. Hence by using Degree of Operating Leverage multiplier we can identify that if the sales will increase by certain percentage then by how much % Net Operating Profits will increase.