Which firm tends to have higher operating leverage? a. A firm with high fixed costs and low variable costs. b. A firm with high fixed costs and high variable costs. c. A firm with low fixed costs and high variable costs. d. A firm with low fixed costs and low variable costs. - Dinesh S

A?

DOL = Q(P-V)/ (Q(P-V)-F) So if F is high, denominator will be low. and so ratio will increase. This eliminates C & D If V is high – Numerator will reduce, and then we cannot be sure. I would go with a) High Fixed, Low Variable… example: Q=1000, P=5, V=2, F=1000 DOL = 3000/2000 = 1.5 If V=1 DOL = 4000 / 3000 = 1.67 so lower variable increases DOL. If F=500 with first example numbers 3000/2500 = 1.2

A

Yes, the answer is A. As, DOL = (Sales - VC)/(Sales - VC - FC) - Dinesh S

A

cpk I don’t think you have to go into that kind of calculation operating leverage means that increase in sales increase earnings a lot- therefore the variable costs need to be low- higher production higher change in profits for the cost to reduce a lot with increase of production , the fixed costs need to be high- that means that first units are real expensive and become cheaper and cheaper at a high rate

I actually did that just to convince myself…

cpk123 Wrote: ------------------------------------------------------- > DOL = Q(P-V)/ (Q(P-V)-F) > > So if F is high, denominator will be low. > > and so ratio will increase. > > This eliminates C & D > > If V is high – Numerator will reduce, and then we > cannot be sure. > > I would go with a) High Fixed, Low Variable… > > example: > Q=1000, P=5, V=2, F=1000 > DOL = 3000/2000 = 1.5 > > If V=1 > DOL = 4000 / 3000 = 1.67 > > so lower variable increases DOL. > > If F=500 > with first example numbers > 3000/2500 = 1.2 4000/3000 = 1.33 which has a lower DOL than if VC is 2. I am thinking A as well but the calculation showed me higher VC lead to higher DOL. Am I missing something?

It should be B. In cpk123 calculation, when V =1, it should be 1.33 as excel86 pointing out. How about V= 0, 5000/4000 = 1.25.

Though I had chosen B initially, The passmaster says it’s ‘A’. - Dinesh S

Operating Leverage is Fixed Costs : Variable Costs so in order to have a high operating leverage ratio you need to have a high FC and a low VC A is correct.

florinpop Wrote: ------------------------------------------------------- > cpk I don’t think you have to go into that kind of > calculation > operating leverage means that increase in sales > increase earnings a lot- therefore the variable > costs need to be low- higher production higher > change in profits > for the cost to reduce a lot with increase of > production , the fixed costs need to be high- that > means that first units are real expensive and > become cheaper and cheaper at a high rate it’s hard for me to remember it out without using a formula. Good suggestion, though!