A firm produces a Contribution Margin of ₹20,00,000, incurs Fixed Operating Costs of ₹12,00,000 (leaving EBIT of ₹8,00,000), and pays Interest Expenses of ₹3,00,000 (leaving EBT of ₹5,00,000). What is the Degree of Operating Leverage (DOL) and Degree of Total Leverage (DTL)?

[ A ]DOL = 2.50x (Contribution / EBIT); DTL = 4.00x (Contribution / EBT: 2.50 * 1.60)[ CORRECT ]

[ B ]DOL = 1.00x; DTL = 2.00x

[ C ]DOL = 1.60x; DTL = 2.50x (Swapping DOL and DFL)

[ D ]DOL = 5.00x; DTL = 10.00x

Takeaway

Option A is correct: DOL = 2.50x (Contribution / EBIT); DTL = 4.00x (Contribution / EBT: 2.50 * 1.60)

Derivation

Degree of Operating Leverage measures how sensitive EBIT is to a change in sales, using fixed operating costs as the amplifier: DOL = Contribution Margin / EBIT = ₹20,00,000 / ₹8,00,000 = 2.50x, meaning a 1% rise in sales lifts EBIT by roughly 2.50%. Degree of Financial Leverage then measures how interest expense further amplifies that swing down to EBT: DFL = EBIT / EBT = ₹8,00,000 / ₹5,00,000 = 1.60x. Multiplying the two chains the full amplification path from sales down to the bottom line: DTL = DOL × DFL = 2.50 × 1.60 = 4.00x, so a 1% sales increase ultimately lifts EPS by roughly 4.00%. A frequent error is swapping DOL and DFL, since both are simple ratios of one profit line over another and are easy to mix up without tracking exactly which two lines each one compares.

Why the others fail

B — DOL = 1.00x; DTL = 2.00x

Assumes zero fixed operating costs, which would make DOL equal to 1.00x; the firm's actual ₹12,00,000 in fixed costs produces a DOL of 2.50x instead.

C — DOL = 1.60x; DTL = 2.50x (Swapping DOL and DFL)

Swaps the two ratios: 1.60x is actually DFL (EBIT/EBT), and 2.50x is actually DOL (Contribution/EBIT) — the labels here are reversed from the correct figures.

D — DOL = 5.00x; DTL = 10.00x

Overstates both leverage figures well beyond what the given Contribution Margin, EBIT, and EBT figures actually produce when correctly divided.