If the fixed cost of production is zero, which one of the following is correct?
A. OL is zero
B. FL is zero
C. CL is zero
D. None of the above
Answer: Option A
Solution (By Examveda Team)
Operating Leverage (OL) is a measure of how a change in sales will affect operating income (EBIT). It exists because of the presence of fixed operating costs, which do not change with the level of production or sales.The formula for Operating Leverage is:
OL = Contribution / EBIT
Contribution is calculated as Sales minus Variable Costs. If a firm has fixed operating costs, then EBIT will be lower than Contribution, making OL greater than 1.
However, if fixed cost of production is zero, it means all costs are variable. There is no cost that remains constant regardless of the production level.
In such a case, Contribution equals EBIT, and there's no leverage effect. This means there is no magnifying impact of sales changes on EBIT.
When there is no fixed cost, Operating Leverage becomes zero or negligible, as there is no risk or benefit from sales fluctuations—every additional unit sold adds directly to profit without covering any fixed cost.
Financial Leverage (FL) is not related to production costs. It arises from interest on debt or other fixed financial obligations, which are not mentioned in the question.
Combined Leverage (CL) is the combination of both OL and FL. If OL is zero but FL is not, then CL is not zero. So we cannot say CL is zero unless both OL and FL are zero.
Therefore, based on the absence of fixed production costs, the correct interpretation is that Operating Leverage is zero.
Hence, the correct answer is Option A: OL is zero.
This Question Belongs to Commerce >> Financial Management
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Investment is the _______________.
A. net additions made to the nation’s capital stocks
B. person’s commitment to buy a flat or house
C. employment of funds on assets to earn returns
D. employment of funds on goods and services that are used in production process
Financial Management is mainly concerned with ______________.
A. All aspects of acquiring and utilizing financial resources for firms activities
B. Arrangement of funds
C. Efficient Management of every business
D. Profit maximization
The primary goal of the financial management is ____________.
A. to maximize the return
B. to minimize the risk
C. to maximize the wealth of owners
D. to maximize profit
In his traditional role the finance manager is responsible for ___________.
A. proper utilisation of funds
B. arrangement of financial resources
C. acquiring capital assets of the organization
D. efficient management of capital
To determine the correct answer, let's analyze the question step-by-step:
### **Key Concepts:**
1. **Fixed Cost (FC):** Costs that do not change with the level of production (e.g., rent, salaries).
2. **Operating Leverage (OL):** Measures the proportion of fixed costs in a firm's cost structure.
- **Formula:**
[
OL = rac{ ext{Fixed Costs}}{ ext{Total Costs}}
]
- If **Fixed Cost (FC) = 0**, then **OL = 0** (since there are no fixed costs).
3. **Financial Leverage (FL) and Combined Leverage (CL):**
- **FL** depends on interest expenses (not directly on fixed production costs).
- **CL** is a combination of operating and financial leverage.
- Since **FC = 0** does not necessarily imply **FL = 0** or **CL = 0**, these options are incorrect.
### **Conclusion:**
If **Fixed Cost (FC) = 0**, then **Operating Leverage (OL) = 0** because there are no fixed costs to leverage.
### **Answer:**
[
oxed{ ext{A. OL is zero}}
]