Operating leverage is the percentage change in operating income resulting from a percentage change in sales. When only one year of data is available, it is calculated as the contribution margin ÷ operating income (EBIT). It measures how a change in volume affects profits. Companies with larger investments and greater fixed costs ordinarily have higher contribution margins and more operating leverage. The degree of operating leverage measures the extent to which fixed assets are used in the production process. A company with a high percentage of fixed costs is more risky than a firm in the same industry that relies more on variable costs to produce. Based on a contribution margin of $.16 per unit ($1 ? $.84 variable cost), the degree of operating leverage is (400,000 x $.16) ÷ [(400,000 x $.16) ? 28,000] = 1.78.
Because 1.2 is obtained by understating the $64,000 contribution margin or understating the $28,000 of fixed costs.
Because 1.35 includes a nonoperating expense (interest) and dividends on preferred stock as fixed costs. It is the degree of financial leverage, not operating leverage.
Because 2.4 could be obtained only by overstating the contribution margin or the fixed costs.
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The degree of operating leverage for Carlisle Company