Question 1 OR (e)
Rise in operating profit from operating leverage
3 marks
- Time to write
- About 6 minutes
Question
Question 1 OR (e) · 3 marksThe following data pertains to Orbit Ltd.
| Sales | ₹9,60,000 |
|---|---|
| Operating Expenses | |
| Variable (30%) | ₹2,88,000 |
| Fixed | ₹4,80,000 |
| Interest on borrowing | ₹24,000 |
With the help of the concept of Operating Leverage, by what percentage will operating profit rise if sales increase by 10%?
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Write it in this order
- 1 DOL from contribution and EBIT 2 marks 4 min
- 2 Percentage rise in operating profit 1 mark 2 min
Try it first. About 6 minutes for 3 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Operating leverage measures the effect of a change in sales on operating profit (EBIT): DOL = % change in EBIT ÷ % change in sales, which equals contribution ÷ EBIT. Interest is a financing cost and does not enter.
| ₹ | |
|---|---|
| Sales | 9,60,000 |
| Less: variable expenses (30%) | 2,88,000 |
| Contribution | 6,72,000 |
| Less: fixed expenses | 4,80,000 |
| Operating profit (EBIT) | 1,92,000 |
DOL = 6,72,000 ÷ 1,92,000 = 3.5.
DOL shows the % change in EBIT from a 1% change in sales, so EBIT changes by DOL × the % change in sales. A 10% rise in sales therefore raises operating profit by 3.5 × 10% = 35%, from ₹1,92,000 to ₹2,59,200. Check: sales ₹10,56,000 − variable ₹3,16,800 − fixed ₹4,80,000 = ₹2,59,200.
Where the 3 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | DOL from contribution and EBIT | 2 |
| 2 | Percentage rise in operating profit | 1 |
| Total | 3 |
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