Let's break down the concept of the degree of operating leverage (DOL). The DOL is a measure of how sensitive the operating income (or EBIT: Earnings Before Interest and Taxes) is to a change in the level of sales. It indicates the percentage change in operating income for a given percentage change in sales.
It is given by the formula:
[tex]\[ \text{DOL} = \frac{\% \text{ Change in EBIT}}{\% \text{ Change in Sales}} \][/tex]
At the break-even point, the company's total revenues exactly equal its total costs, meaning that its operating income is zero.
1. Right after the break-even point: As soon as the sales surpass the break-even point, any increase in sales contributes more significantly to the operating income because a part of the revenues no longer goes to covering fixed costs but rather contributes directly to profit. Thus, right after the break-even point, the degree of operating leverage is at its highest.
2. As sales continue to increase: As sales continue to increase beyond the break-even point, the contribution towards fixed costs decreases relative to the revenue, meaning that each additional unit sold contributes less proportionately to the increase in operating income. Thus, the degree of operating leverage decreases as sales increase.
Therefore, the correct answer is:
O Highest right after the break-even point, and then decreases as sales increase.
