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A company has operating leverage of 5 and operating income of $20,000. Sales rise by 20%. What is the new operating income?
A$24,000
B$30,000
C$40,000
D$70,000
Answer & Solution
Correct answer: C. $40,000
1. The percentage change in sales is multiplied by operating leverage to give the percentage change in operating income.
2. 20% times 5 gives a 100% increase in operating income.
3. 100% of the existing $20,000 is a further $20,000.
4. New operating income is $20,000 plus $20,000, which is $40,000.
5. $24,000 applies the 20% straight to income and ignores the leverage multiple.
6. A company with leverage of 2 would gain only 40%, taking income from $50,000 to $70,000.
_Source: Jonick, Principles of Managerial Accounting (UNG Press, CC BY-SA 4.0), section 5.4 Operating Leverage_
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