Which of the following is the correct interpretation of a degree of operating leverage (DOL) of 5?

• A. A 5% increase in sales will result in a 1% increase in operating income.
• B. Operating expenses are 5 times greater than sales revenue.
• C. A 1% increase in sales will result in a 5% increase in operating income.
• D. Net sales are 5 times greater than net income.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of Degree of Operating Leverage (DOL). DOL measures the sensitivity of operating income to changes in sales. It is calculated as the percentage change in operating income divided by the percentage change in sales.
2. Step 2: Recall the formula for DOL: \( DOL = \frac{\text{Percentage Change in Operating Income}}{\text{Percentage Change in Sales}} \). This formula indicates how much operating income will change for a given change in sales.
3. Step 3: Interpret the given DOL value of 5. A DOL of 5 means that for every 1% increase in sales, operating income will increase by 5%. This is because the DOL value represents the multiplier effect of sales changes on operating income.
4. Step 4: Analyze the options provided. The correct interpretation aligns with the formula and concept of DOL. Specifically, the statement 'A 1% increase in sales will result in a 5% increase in operating income' correctly reflects the meaning of a DOL of 5.
5. Step 5: Eliminate incorrect options. For example, 'Operating expenses are 5 times greater than sales revenue' and 'Net sales are 5 times greater than net income' are unrelated to the concept of DOL. Focus on the relationship between sales and operating income to identify the correct interpretation.