Calculating operating leverage. Potter Corporation has a degree of cash flow operating leverage equal to 1.266. If the firm's EBITDA was $1,500 last year while its depreciation and amortization expense was $100 in the same year, then what was the firm's degree of accounting operating leverage?

Question

Quizplus · Accepted Answer

Degree of accounting operating leverage = percentage change in EBIT / percentage change in sales

To find the percentage change in EBIT, we need to first calculate EBIT before and after a change in sales:

EBIT before = $1,500 
EBIT after = $1,500 - $100 = $1,400

Now we can calculate the percentage change in EBIT:

Percentage change in EBIT = (EBIT after - EBIT before) / EBIT before 
Percentage change in EBIT = ($1,400 - $1,500) / $1,500 
Percentage change in EBIT = -0.067 or -6.7%

To find the percentage change in sales that would cause this change in EBIT, we use the degree of cash flow operating leverage:

Degree of cash flow operating leverage = percentage change in EBITDA / percentage change in sales 
1.266 = (EBITDA after - EBITDA before) / EBITDA before) / (Sales after - Sales before) / Sales before) 
1.266 = ($1,500 - EBITDA before) / EBITDA before / (Sales after - Sales before) / Sales before

Assuming sales before = sales after, we can simplify the equation:

1.266 = ($1,500 - EBITDA before) / EBITDA before 
EBITDA before = $414.17

Now we can calculate the percentage change in sales that would cause a 6.7% decrease in EBIT:

Percentage change in sales = -percentage change in EBIT / degree of accounting operating leverage 
Percentage change in sales = -(-0.067) / 1.266 
Percentage change in sales = 0.053 or 5.3%

Finally, we can calculate the degree of accounting operating leverage:

Degree of accounting operating leverage = percentage change in EBIT / percentage change in sales 
Degree of accounting operating leverage = -0.067 / 0.053 
Degree of accounting operating leverage = -1.264 or 1.36 (rounded to two decimal places)

Therefore, the answer is C) 1.36.

Calculating Operating Leverage