Abstract
The concept of operating leverage is used to measure the sensitivity of operating income to the change in total sales. The change in total sales, however, may come from a price adjustment. We examine the impact of operating leverage on operating income due to a price adjustment. The results show that, in the short run, operating leverage is actually preferable in a price cut situation; while in a price raise situation, operating leverage adds downside risk to the firm's profit. These results are particularly pertinent to the defense industry and government units of similar nature. For example, a defense contractor may face a fixed-price contract with the Department of Defense and, therefore, is forced to adjust the sales price toward the contract price. Hence, it is desirable to know how operating leverage affects the operating income when the sales price is changed.