ECONOMICS
FINANCIAL MARKETS
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Revenue will increase much faster than expenses
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Profit will increase much faster than expenses
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A large part of increase in revenue will translate into increase in profit
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None of the above
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Detailed explanation-1: -If a business has a high degree of operating leverage, it’s a reliable indication that its proportion of fixed to variable costs is high. As such, the business is using more fixed assets to support its core business. Ultimately, this means that the business will be able to expand its profit margin more quickly.
Detailed explanation-2: -Industries like Mining, Utilities, and Real Estate have both the highest operating and financial leverages (see table below). In good times these industries can benefit more from each additional sale as their fixed costs are diluted by the increase in revenue.
Detailed explanation-3: -fixed costs to magnify returns at high levels of operation. Operating leverage involves intensive investment in fixed costs. The fixed costs include administration costs, rent, and the cost of machinery. A firm may incur fixed expenses while attempting to ensure that the profit levels remain high.
Detailed explanation-4: -The higher the degree of operating leverage (DOL), the more sensitive a company’s earnings before interest and taxes (EBIT) are to changes in sales, assuming all other variables remain constant. The DOL ratio helps analysts determine what the impact of any change in sales will be on the company’s earnings.