Interpretation

In case 2, 16.7 per cent decrease in sales volume (from 300 units to 250 units) leads to 100 per cent decline in the EBIT (from Rs 1,000 to zero). On the other hand, a 16.7 per cent increase In the sales level in case 1 (from 300 units to 350 units) results in 100 per cent increase In EBIT (from Rs 1,000 to Rs 2,000).

The two illustrations Tables clearly show that when a firm has fixed operating costs, an increase in sales volume results in a more than proportionate increase in EBIT. Similarly, a decrease in the level of sales has an exactly opposite effect. This is operating leverage, the former being favorable leverage, while the latter is unfavorable. Leverage, thus, works in both directions.

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