If a firm doubled its level of fixed costs but maintained its operating leverage,then one explanation may be that:
A) depreciation expense increased to offset the increase.
B) sales revenue also doubled and the proportion of variable costs did not change.
C) sales revenues declined and the proportion of variable costs doubled.
D) pretax profits decreased.

Question

Quizplus · Accepted Answer

If the firm maintained its operating leverage, it means that the proportion of fixed costs to total costs remained the same. Therefore, if fixed costs doubled, sales revenue must also have doubled to maintain the same operating leverage. If the proportion of variable costs did not change, it means that the firm was able to enjoy the benefits of economies of scale, resulting in higher profit margins. Thus, the pretax profits may not have decreased, but could have increased due to higher sales revenue and economies of scale. Choice A and C are not correct because they assume an increase in variable costs or a decline in sales revenue, which is not stated in the question.

If a Firm Doubled Its Level of Fixed Costs but Maintained