Which of the following is the correct interpretation of a degree of operating leverage of 5?
A) Operating leverage of 5 means that the company would need to increase sales by 5 times in order to hit its break-even point.
B) Operating leverage of 5 means that if sales increase by 5% the firm will hit its break-even point.
C) Operating leverage of 5 means that sales can decrease by 5% before the firm's current level of sales will hit the break-even point.
D) Operating leverage of 5 means that if sales increase by 5%, there will be a 25% increase in the firm's pretax profit.
E) Operating leverage of 5 measures the degree of debt employed by the firm's debt structure.

Question

Quizplus · Accepted Answer

A degree of operating leverage of 5 means that a 5% increase in sales will result in a 25% increase in the firm's pretax profit. This is because the degree of operating leverage measures the percentage change in pretax profit due to a percentage change in sales. Thus, option D is the correct interpretation. Options A, B, and C are incorrect because they do not reflect the true meaning of the degree of operating leverage. Option E is also incorrect as it refers to the firm's debt structure, which is not related to the degree of operating leverage.

Which of the Following Is the Correct Interpretation of a Degree