CFA Level ICorporate IssuersMedium
Falkirk Industries sells 100,000 units annually at a price of $50 per unit. Variable cost per unit is $30, and fixed operating costs are $800,000. Based on this operating structure, what is Falkirk's degree of operating leverage (DOL) at this sales level?
- A1.20
- B1.67
- C2.50
- D1.43
Show answer & explanationAnswer & explanation
Correct answer: B. 1.67
Contribution margin = (Price − Variable cost) × Quantity = ($50 − $30) × 100,000 = $2,000,000. EBIT = Contribution margin − Fixed costs = $2,000,000 − $800,000 = $1,200,000. DOL = Contribution margin / EBIT = $2,000,000 / $1,200,000 = 1.67, meaning a 1% change in sales produces a 1.67% change in EBIT.
Why the other options are wrong
- A. Understates leverage; does not match CM/EBIT calculation.
- C. Overstates leverage; would result from an incorrect fixed cost figure.
- D. Incorrect ratio; likely results from using EBIT/CM instead of CM/EBIT.
Degree of Operating Leverage (DOL)
DOL measures the sensitivity of EBIT to changes in sales, driven by the proportion of fixed operating costs in the cost structure.
- DOL = Contribution Margin / EBIT
- Higher fixed costs relative to variable costs increase DOL
- Higher DOL means greater EBIT volatility for a given change in sales
Memory trick: Fixed costs act like a lever — small sales moves, big EBIT swings.