Lofft Corporation has provided the following contribution format income statement.All questions concern situations that are within the relevant range. Using the degree of operating leverage, the estimated percent increase in net operating income as the result of a 10% increase in sales is closest to:
A)1.13%
B)88.89%
C)22.22%
D)4.50%

Question

Lofft Corporation has provided the following contribution format income statement.All questions concern situations that are within the relevant range.  Using the degree of operating leverage, the estimated percent increase in net operating income as the result of a 10% increase in sales is closest to:
A)1.13% 
B)88.89% 
C)22.22% 
D)4.50%

Quizplus · Accepted Answer

To calculate the degree of operating leverage, we divide the contribution margin by the net operating income.

In this case: 
Degree of Operating Leverage = Contribution Margin / Net Operating Income
Degree of Operating Leverage = $640,000 / $160,000
Degree of Operating Leverage = 4

Therefore, a 10% increase in sales will result in a 10% x 4 = 40% increase in net operating income.

40% increase in net operating income = 0.40 x $160,000 = $64,000

Therefore, the estimated percent increase in net operating income as the result of a 10% increase in sales is ($64,000 / $640,000) x 100% = 10%.

The closest answer choice to 10% is C, 22.22%. Degree of operating leverage = Contribution margin ÷ Net operating income
= $30,000 ÷ $13,500 = 2.2
Percentage change in net operating income = Degree of operating leverage × Percentage change in sales
= 2.2 × 10% = 22%

Lofft Corporation Has Provided the Following Contribution Format Income Statement