Question

Titan Industries has a degree of operating leverage of 2. Titan is considering automating some of its plants, allowing it to reduce its labor force. The increased fixed cost of maintaining the machinery, however, will keep Titan's total production costs the same. Which one of the following is most likely true should Titan automate the plants?

A. the degree of operating leverage will remain the same

B. a 1% increase in quantity sold will increase OCF by 2%

C. a 1% increase in quantity sold will increase OCF by more than 2%

D. the degree of operating leverage will likely decrease, but the change is uncertain.

E. a 1% increase in quantity sold will increase OCF by less than 2%

Answer 1

The variable costs has come down, so contribution will increase faster with more no of units sold than earlier, which will increase the EBIT.

The operating leverage will be higher than 2 as variable costs are lower and fixed costs are higher. [ remember : Operating leverage = contribution/EBIT]

so the result is 1% increase in sales will lead to more than 2% increase in EBIT

so correct answer is :  a 1% increase in quantity sold will increase OCF by more than 2%

Answer : C : C. a 1% increase in quantity sold will increase OCF by more than 2% (Thumbs up please)