A firm that has total fixed costs of $40,000 sells its output for $250 per unit and has an average variable cost of $150. If the firm's cost and revenue curves are linear and output is equal to 500 units, what is the firm's degree of operating leverage?
A) 5
B) 4
C) 3
D) None of the above is correct.

Question

Quizplus · Accepted Answer

The degree of operating leverage is calculated as the percentage change in EBIT divided by the percentage change in sales. In this case, the percentage change in EBIT is equal to the percentage change in revenue minus the percentage change in variable costs. The percentage change in revenue is equal to the change in revenue divided by the original revenue, which is (250 - 150) / 250 = 0.4. The percentage change in variable costs is equal to the change in variable costs divided by the original variable costs, which is (150 - 100) / 100 = 0.5. Therefore, the percentage change in EBIT is 0.4 - 0.5 = -0.1. The percentage change in sales is equal to the change in sales divided by the original sales, which is (500 - 400) / 400 = 0.25. Therefore, the degree of operating leverage is -0.1 / 0.25 = -0.4.

A Firm That Has Total Fixed Costs of $40,000 Sells