Question 3 (a)
Operating leverage and EBIT at changed sales
8 marks
- Time to write
- About 16 minutes
From an older CBCS paper
Question
Question 3 (a) · 8 marksA Firm's product sells at ₹10 per Unit. Its Variable cost Ratio is 70%, and its Fixed Cost is ₹12,000. Its present sales are 12,000 units. Calculate:
Degree of Operating Leverage.
The New EBIT if sales increase by 40%.
The New EBIT if sales fall by 25%.
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
Read from the question
- (i)–(iii)3 items, each marked on its own: give each its share.
- CalculateFormula first, then the working, then the answer with its unit (₹, %, units).
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Contribution, EBIT and DOL 3 marks 5 min
- 2 EBIT after a 40% rise 2½ marks 4 min
- 3 EBIT after a 25% fall 2½ marks 4 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Try it first. About 16 minutes for 8 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.
| Particulars (₹) | Present | Sales +40% | Sales −25% |
|---|---|---|---|
| Units | 12,000 | 16,800 | 9,000 |
| Sales @ ₹10 | 1,20,000 | 1,68,000 | 90,000 |
| Less: variable cost (70%) | 84,000 | 1,17,600 | 63,000 |
| Contribution | 36,000 | 50,400 | 27,000 |
| Less: fixed cost | 12,000 | 12,000 | 12,000 |
| EBIT | 24,000 | 38,400 | 15,000 |
(i) Degree of operating leverage = contribution ÷ EBIT = 36,000 ÷ 24,000 = 1.5.
(ii) New EBIT if sales rise by 40%: ₹38,400. Check with DOL, the % change in EBIT ÷ % change in sales: EBIT rises by 1.5 × 40% = 60%; 24,000 × 1.60 = ₹38,400.
(iii) New EBIT if sales fall by 25%: ₹15,000. Check: EBIT falls by 1.5 × 25% = 37.5%; 24,000 × 0.625 = ₹15,000.
Because of the fixed cost, a change in sales produces a 1.5 times larger percentage change in EBIT, in either direction: operating leverage magnifies both gains and losses.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Contribution, EBIT and DOL | 3 |
| 2 | EBIT after a 40% rise | 2.5 |
| 3 | EBIT after a 25% fall | 2.5 |
| Total | 8 |
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