What is the fixed-cost expenditure for a firm with a DOL of 4.5 that generates pretax profits of $1 million and has $600,000 in depreciation expense? (Enter the answer in millions)
A)$1.1 million
B)$2.1 million
C)$2.9 million
D)$3.9 million

Question

Quizplus · Accepted Answer

The Degree of Operating Leverage (DOL) is calculated as: DOL = % Change in EBIT / % Change in Sales. However, when not given percentage changes, it can also be understood as: DOL = EBIT / (EBIT - Fixed Costs). Given that the DOL is 4.5 and EBIT (Earnings Before Interest and Taxes) is essentially the pretax profits of $1 million, we can rearrange the formula to solve for fixed costs: 4.5 = $1 million / ($1 million - Fixed Costs). Solving this equation, we find that Fixed Costs = $1 million - ($1 million / 4.5) = $1 million - $0.222 million = $0.778 million. However, since depreciation is a non-cash fixed cost that has already been subtracted to arrive at the EBIT, we need to add it back to find the total fixed-cost expenditure. Therefore, total fixed costs = $0.778 million + $0.6 million (depreciation) = $1.378 million. This does not match any of the provided options directly, indicating a need to reevaluate the calculation or the interpretation of the question. Given the options and the context, the correct approach to find the fixed-cost expenditure involves understanding the relationship between DOL, EBIT, and fixed costs correctly, and considering the depreciation as part of the fixed costs, the calculation should directly relate to how fixed costs impact the DOL and EBIT. The mistake in the initial explanation lies in the misinterpretation of how DOL is applied to the calculation of fixed costs, especially in the context of including depreciation. The correct calculation should directly consider the total fixed costs including depreciation as part of the equation from the start, leading to a reevaluation of the answer based on the given options and the correct understanding of DOL.

What Is the Fixed-Cost Expenditure for a Firm with a DOL