A firm has a DOL = 2.5. If sales decrease by 20%, then OCF will ____________.
A) decrease by 20%
B) increase by 5%
C) increase by 20%
D) decrease by 12.5%
E) decrease by 50%

Question

Quizplus · Accepted Answer

The Degree of Operating Leverage (DOL) measures the sensitivity of a firm's operating cash flow (OCF) to changes in its sales. The formula for the impact on OCF given a change in sales is: % Change in OCF = DOL * % Change in Sales. Here, with a DOL of 2.5 and a 20% decrease in sales, the calculation is 2.5 * (-20%) = -50%, indicating that OCF will decrease by 50%.

A Firm Has a DOL = 2