Operating Leverage Calculation | Clay Industries Tooling Division

Operating Leverage Calculation

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Question

Clay Industries, a large industrial firm, is examining the operating leverage of its tooling division during the last year. Consider the following information:

% change in EBIT during the last year 28%

Sales for period 1$435,000 -

Sales for period 2$578,000 -

Cost of debt 7.75%

Expected return on the market 15%

Risk-free rate 4.55%

Beta 1.05 -

Given this information, what is the operating leverage of this division during the time period in question?

Answers

Explanations

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A. B. C. D. E. F.

Explanation

To calculate the degree of operating leverage, use the following equation: {% change in EBIT/% change in sales}. In this example, the percentage change in EBIT is provided. However, the percentage change in sales must be calculated, and can be found by the following: {[sales in period 2 - sales in period 1]/sales in period

1}. Incorporating the given information into this equation yields a percentage change in sales of 32.87%. From this point on, the calculation of the DOL is straightforward, and can be found as follows: {% change in EBIT 28%/% change in sales 32.87%}= 0.8518. In attempt to trick you, the cost of debt, along with the components of the Capital Asset Pricing Model have been provided. None of these figures are relevant in the calculation of the Degree of Operating Leverage.

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