Ace Consulting, a corporate finance consulting firm, is examining the operating performance of Microscam Incorporated. In their analysis, Ace Consulting has identified the following information:
Year 1 interest paid $28,000 -
Year 2 interest paid $35,000 -
Year 1 sales $1,675,000 -
Year 2 sales $1,895,000 -
Year 1 EBIT $750,000 -
Year 2 EBIT $987,500 -
Cost of debt 7.70%
Given this information, what is the Degree of Operating Leverage for this firm during the time period in question?
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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, neither the percentage change in sales, neither the percentage change in EBIT are provided, and must be calculated manually. To calculate the percentage change in sales, use the following equation: {[sales in year 2 - sales in year 1]/sales in year 1}. Incorporating the given information into this calculation yields a % change in sales of 13.13%. To calculate the percentage change in EBIT, use the same equation as follows: {[EBIT in year 2 - EBIT in year 1]/EBIT in year 1}. Incorporating the given information into this calculation yields a percentage change in the EBIT of 31.67%. Finally, to calculate the Degree of Operating Leverage, divide the percentage change in
EBIT by the percentage change in sales, which derives a DOL of 2.412. The "interest paid" information is irrelevant in the calculation of the DOL, rather is incorporated into a determination of the Degree of Financial Leverage. This information has been provided to trick you. Additionally, the Degree of Operating
Leverage can be calculated regardless of whether an appropriate discount rate has been provided or not.