You are the manager of a project that has a degree of operating leverage of 1.84 and a required return of 15 percent. Due to the current state of the economy, you expect unit sales to decrease by 3.5 percent next year. What change should you expect in the operating cash flows next year given your sales prediction?
A) 6.44 percent decrease
B) 4.50 percent decrease
C) 5.34 percent decrease
D) 6.44 percent increase
E) 5.34 percent increase

Question

Quizplus · Accepted Answer

The degree of operating leverage (DOL) measures the sensitivity of a company's operating income to its sales. The formula to calculate the percentage change in operating cash flows given a percentage change in sales is: % Change in Operating Cash Flows = DOL * % Change in Sales. Given a DOL of 1.84 and an expected decrease in sales of 3.5%, the calculation is: 1.84 * (-3.5%) = -6.44%. Therefore, you should expect a 6.44 percent decrease in operating cash flows next year.

You Are the Manager of a Project That Has a Degree