Asked by Nikolaos Filaretos on Jul 15, 2024
Verified
Bendel Inc.has an operating leverage of 7.3.If the company's sales increase by 3%, its net operating income should increase by about:
A) 243.3%
B) 7.3%
C) 21.9%
D) 3.0%
Operating Leverage
An indicator of the way in which growth in revenue results in an increase in operating profit, revealing the ratio of fixed to variable expenses within a business.
Net Operating Income
The total profit of a company after operating expenses are deducted, but before taxes and interest payments.
Sales Increase
It refers to the upward change in the number of products sold or the value of sales over a specific period.
- Interpret and calculate the degree of operating leverage and its impact on net operating income.
Verified Answer
7.3 = CM / NOI
Therefore, CM = 7.3 x NOI
If sales increase by 3%, then the new contribution margin (CM') would be:
CM' = CM + (0.03 x sales)
And the new net operating income (NOI') would be:
NOI' = sales - variable costs - fixed costs
NOI' = sales x (1 - variable cost ratio) - fixed costs
Using the operating leverage equation with the new values:
7.3 = CM' / NOI'
7.3 = (CM + 0.03s) / (s(1 - VC%) - FC)
7.3 = (7.3NOI + 0.03s) / (s(1 - VC%) - FC)
Solving for NOI':
NOI' = (s - VC%s - FC) x 7.3 / (1 - 0.03s / CM)
Plugging in the given values:
NOI' = (1.03s - VC%s - FC) x 7.3 / (1 - 0.03s / CM)
Since we don't know the values of s, VC%, CM, or FC, we can't calculate the exact increase in net operating income. However, we can see that it will be greater than 3% (option D) due to the operating leverage of 7.3. The correct answer is therefore option C (21.9%).
= 7.3 × 3% = 21.9%
Learning Objectives
- Interpret and calculate the degree of operating leverage and its impact on net operating income.
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