Question

You estimate that your cattle farm will generate $0.15 million of profits on sales of $3 million under normal economic conditions and that the degree of operating leverage is 2. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Enter your answers in millions.)

a. What will profits be if sales turn out to be $1.5 million?

b. What if they are $4.5 million?

Answer 1

Degree of operating leverage = % Change in EBIT or profits / % Change in Sales

or, % Change in Profits = % Change in Sales x Degree of operating leverage

a) % Change in Sales = ($1.5 million - $3 million) / $3 million = (-)0.50 or (-)50%

% Change in Profits = (-)50% x 2 = (-)100%

Therefore, Profits = $0.15 million - 100% = 0

b) % Change in Sales = ($4.5 million - $3 million) / $3 million = 0.50 or 50%

% Change in Profits = 50% x 2 = 100%

Therefore, Profits = $0.15 million + 100% = $0.30 million