Operating leverage is an important concept for many companies. Required: A. Define operating leverage.B. Assume that a firm pays no income taxes and is planning to increase its selling price. If sales volume in units does not change, what will be the effect on the operating leverage factor? Explain.C. Assume that another firm that pays no income taxes is planning to increase total fixed manufacturing costs and decrease variable manufacturing costs per unit. At the present volume of production, the total manufacturing costs will be unchanged. What will this change do to the operating leverage factor? Explain.
What will be an ideal response?
A. Mathematically, operating leverage is contribution margin divided by income. The degree of operating leverage indicates a company's ability to operate with a given amount of fixed cost relative to variable cost.
B. The increase in selling price with no change in units sold will increase both contribution margin and net income by the same dollar amount. The percentage change in net income will be greater than the percentage change in contribution margin and, thus, the operating leverage factor will decrease.
C. The decrease in variable costs will increase the contribution margin, but net income will not change because total costs remain the same. The operating leverage factor will therefore increase.
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