Question

Data Recovery Systems (DRS) has a degree of operating leverage (DOL) equal to 3.2x and a degree of total leverage (DTL) equal to 8x. DRS forecasts that this year's sales will be $300,000 and that EBIT will be $180,000. If sales actually turn out to be $313,500, what will DRS's EBIT be?

Answer 1

Answer:

The DRS's EBIT will be $205,920.

Explanation:

Degree of operating leverage measures how EBIT will change with change in sales

Degree of operating leverage (DOL) = % change in EBIT / % change in sales

In our case, DOL = 3.2x

Sales forecast = $300,000

Actual sales = $313,500

% change in sales = (Actual sales - forecast )/ forecast = (313,500 - 300,000) / 300,000

                              = 4.5%

EBIT forecast = $180,000

Now putting everything in DOL formula

3.2 = % change in EBIT / % change in sales = % change in EBIT / 4.5

% change in EBIT = 3.2 * 4.5

                             = 14.4%

Actual EBIT = Forecast *(1 + % change)

                    = 180,000*(1 + 0.014)

                    = $205,920

Therefore, The DRS's EBIT will be $205,920.