The correct answer is: A. Contribution ÷ EBIT
Operating leverage is a measure of how sensitive a company’s operating income is to changes in its sales. It is calculated by dividing a company’s contribution margin by its earnings before interest and taxes (EBIT).
Contribution margin is the amount of revenue that a company keeps after paying for variable costs. EBIT is a company’s earnings before interest and taxes.
A high operating leverage means that a small change in sales can lead to a large change in EBIT. This is because a company with high operating leverage has a lot of fixed costs. When sales go up, the company’s fixed costs do not change, so its EBIT goes up a lot. When sales go down, the company’s fixed costs do not change, so its EBIT goes down a lot.
A low operating leverage means that a small change in sales can lead to a small change in EBIT. This is because a company with low operating leverage has a lot of variable costs. When sales go up, the company’s variable costs go up, so its EBIT does not go up as much. When sales go down, the company’s variable costs go down, so its EBIT does not go down as much.
Operating leverage can be a good thing or a bad thing. It is a good thing if a company is able to generate a lot of profit with a small amount of sales. It is a bad thing if a company has a lot of fixed costs and is not able to generate enough profit to cover its fixed costs.
Here is a brief explanation of each option:
- Option A: Contribution ÷ EBIT. This is the correct answer. Contribution margin is the amount of revenue that a company keeps after paying for variable costs. EBIT is a company’s earnings before interest and taxes.
- Option B: EBIT ÷ PBT. This is not the correct answer. PBT is a company’s profit before tax. It is calculated by subtracting taxes from EBIT.
- Option C: EBIT ÷ Interest. This is not the correct answer. Interest is a company’s cost of borrowing money. It is calculated by multiplying the amount of money that a company borrows by the interest rate.
- Option D: EBIT ÷ Tax. This is not the correct answer. Tax is a company’s liability to the government. It is calculated by multiplying a company’s taxable income by the tax rate.