Operating Leverage

1
Operating Leverage

• The physical intuition behind it

2
Degree of operating leverage (DOL)
Degree of financial leverage (DFL)

• Sensitivity of changes in EBIT to changes in
  sales
• A degree of operating leverage of 2 (for example)
  means that a 1 increase in sales leads to a 2
  increase

• Sensitivity of changes in net income to changes
  in EBIT
• A degree of financial leverage of 2 (for example)
  means that a 1 increase in EBIT leads to a 2
  increase in net income.

3
Including depreciation

• Sales
• Fixed Costs
• Variable Costs
• EBIT
• Interest
• Pre-tax Income
• Taxes
• Net Income

DOL acts as a multiplier effect here
DFL acts as a multiplier effect here
Total effect of a 1 increase in sales? An
increase in net income of (DOLDFL).
4
An interactive leverage model

• http//www.wigginslift.com/mwjr/ilm/
• This applet nicely illustrates the idea that
  degree of operating leverage and degree of
  financial leverage work with each other
  multiplicatively.