How does a decrease in sales affect a company with high operating leverage?a.The impact on profits is minimalb.Profits decrease at a proportionally higher ratec.Profits decrease at a proportionally lower rated.It does not affect profits
Question
How does a decrease in sales affect a company with high operating leverage?a.The impact on profits is minimalb.Profits decrease at a proportionally higher ratec.Profits decrease at a proportionally lower rated.It does not affect profits
Solution 1
b. Profits decrease at a proportionally higher rate
Here's why:
Operating leverage refers to the percentage of fixed costs in a company's cost structure. High operating leverage means that a company has a high proportion of fixed costs, such as rent or salaries, and a low proportion of variable costs, such as raw materials or direct labor.
When a company with high operating leverage experiences a decrease in sales, its variable costs will decrease proportionally. However, its fixed costs will remain the same. This means that a larger proportion of each sales dollar is needed to cover the fixed costs, resulting in a proportionally higher decrease in profits.
So, when sales decrease, a company with high operating leverage will see its profits decrease at a proportionally higher rate compared to a company with low operating leverage. This is because the company with high operating leverage has less ability to reduce its costs in response to the decrease in sales.
Solution 2
b. Profits decrease at a proportionally higher rate
Here's why:
Operating leverage refers to the percentage of fixed costs in a company's cost structure. High operating leverage means that a company has a high proportion of fixed costs, such as rent or salaries, and a low proportion of variable costs, such as raw materials or direct labor.
When a company with high operating leverage experiences a decrease in sales, its variable costs will decrease proportionally. However, its fixed costs will remain the same. This means that a larger proportion of each sales dollar is needed to cover the fixed costs, resulting in a proportionally higher decrease in profits.
So, when sales decrease, a company with high operating leverage will see its profits decrease at a proportionally higher rate compared to
Similar Questions
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