Kulwicki Corporation wants to determine the effect of an expansion of its sales on its operating income (EBIT).The firm's current degree of operating leverage is 2.75.It projects new unit sales to be 170,000,an increase of 45,000 over last year's level of 125,000 units.Last year's EBIT was $60,000.Based on a degree of operating leverage of 2.75,what is this year's expected EBIT with the increase in sales?
A) $119,400
B) $120,594
C) $97,908
D) $138,504
E) $146,862

Question

Quizplus · Accepted Answer

The correct answer is A. $119,400.The degree of operating leverage (DOL) is a measure of the sensitivity of operating income to changes in sales volume. It is calculated as the percentage change in operating income divided by the percentage change in sales volume.In this case, the DOL is 2.75, which means that a 1% increase in sales volume will lead to a 2.75% increase in operating income.The firm's current sales volume is 125,000 units, and its EBIT is $60,000. If the firm increases its sales volume by 45,000 units, its new sales volume will be 170,000 units.Using the DOL, we can calculate the firm's new EBIT as follows:New EBIT = Old EBIT * (New Sales Volume / Old Sales Volume)^DOLNew EBIT = $60,000 * (170,000 / 125,000)^2.75New EBIT = $119,400Therefore, the firm's expected EBIT with the increase in sales is $119,400.

Kulwicki Corporation Wants to Determine the Effect of an Expansion