Mike's Maintenance Co. had the following results last month: Revenues were $9,500, contribution margin totaled $4,500, and operating income was $500. Revenues are expected to grow by 5% next month. Using the principle of degree of operating leverage (DOL) and based on the projected revenue increase, what can Mike's expect in operating income next month?
A) $650
B) $700
C) $725
D) $850

Question

Quizplus · Accepted Answer

DOL is equal to contribution margin divided by operating income, or $4,500 ÷ $500 = 9.0. The projected revenues increase of 5% must be multiplied by the DOL of 9.0 to get the multiplier to apply to the operating income expected under a scenario of 5% sales revenue growth. Thus, operating income must be multiplied by 9.0 × 5%, or 1.45, to arrive at expected operating income under the new revenue assumption. Last month's operating income of $500 × 1.45 = $725 in projected operating income.