Business Finance - Study Mode

Explanation

Solution: First, let's understand what operating leverage is. It basically measures how sensitive a company's operating income (profit from its core business) is to changes in sales. A high operating leverage means a small change in sales can lead to a big change in profit. To calculate operating leverage, we use a simple formula: Operating Leverage = Contribution Margin / Earnings Before Interest and Taxes (EBIT) Let's find each of these components. 1. Contribution Margin: This is the difference between your sales revenue and your variable costs. In this case: Contribution Margin = Sales - Variable Costs = Rs. 74 lakh - Rs. 40 lakh = Rs. 34 lakh 2. Earnings Before Interest and Taxes (EBIT): This is also known as operating income or operating profit. It's what's left after you subtract both variable and fixed costs from your sales. EBIT = Sales - Variable Costs - Fixed Costs = Rs. 74 lakh - Rs. 40 lakh - Rs. 8 lakh = Rs. 26 lakh Now we can plug these values into the operating leverage formula: Operating Leverage = Rs. 34 lakh / Rs. 26 lakh = 1.3076 Rounding this value we get 1.31 Therefore, the operating leverage of the firm is approximately 1.31. So, the correct answer is Option C: 1.31 .