Degree of Operating Leverage

Cost-volume-profit analysis is also a useful tool for analyzing the financial characteristics of alternative production systems. This analysis focuses on how total costs and profits vary with operating leverage or the extent to which fixed production facilities versus variable production facilities are employed.

Q = Fixed Costs + Profit Requirement Profit Contribution = $100,000 + $20,000 $8

= 15,000 units

The relation between operating leverage and profits is shown in Figure 8.13, which contrasts the experience of three firms, A, B, and C, with differing degrees of leverage. The fixed costs of firm B are typical. Firm A uses relatively less capital equipment and has lower fixed costs, but it has a steeper rate of increase in variable costs. Firm A breaks even at a lower activity level than

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