Question

The Sterling Tire Company’s income statement for 20X1 is as follows:

STERLINE TIRE COMPANY Income Statement For the year ended December 31, 20X1
Sales (20,000 tires at \(60 each)	\)1,200,000
Less: variable costs (20,000 tires at \(30)	600,000
Less: fixed cost	400,000
Earnings before interest and taxes (EBIT)	\)200,000
Interest expenses	50,000
Earning before taxes (EBT)	\(150,000
Income tax expenses (30%)	45,000
Earning after taxe (EAT)	\)105,000

Given this income statement, compute the following:

a. Degree of operating leverage.

Short answer

The degree of operating leverage is 3.

Step-by-step solution

Contribution

$\begin{array}{rcl}\mathrm{Contribution}& =& \mathrm{Sales}-\mathrm{Variable}\mathrm{cost}\\ & =& \$1,200,000-\$600,000\\ & =& \$600,000\end{array}$

Degree of operating leverage

$\begin{array}{rcl}\mathrm{Degree}\mathrm{of}\mathrm{operating}\mathrm{leverage}& =& \frac{\mathrm{Contribution}}{\mathrm{EBIT}}\\ & =& \frac{\$600,000}{\$200,000}\\ & =& 3\end{array}$