Computing and interpreting the degree of operating leverage (DOL) It is December 31. Last year, Carter...

Computing and interpreting the degree of operating leverage (DOL)

It is December 31. Last year, Carter Chemical Co. had sales of $8,000,000, and it forecasts that next year’s sales will be $7,600,000. Its fixed costs have been and are expected to continue to be $4,400,000, and its variable cost ratio is 12.50%. Carter’s capital structure consists of a $13.5 million bank loan, on which it pays an interest rate of 9%, and 250,000 shares of common equity. The company’s profits are taxed at a marginal rate of 40%.

Given this data, complete the following sentences:

•	The percentage change in the company’s sales is .
•	The percentage change in Carter’s EBIT is .
•	The degree of operating leverage (DOL) at $7,600,000 is .

There are several ways to use and interpret a firm’s DOL value. Consider the following statement and indicate whether it accurately reflects the meaning or an appropriate use of a firm’s DOL value.

Assume that at a given sales level, a firm’s DOL is 2.5. This means that a 1% change in the firm’s sales will result in a corresponding 2.5% change in the firm’s EBIT.

True or False: This statement accurately describes a firm’s DOL.

True

False

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