If the business cycle is just beginning its upswing, which firm would you anticipate would be likely to show the best growth in EPS over the next year? Firm A has high combined leverage and Firm B has low combined leverage.
A) Firm A
B) Firm B
C) Indifferent between the two
D) It depends on how much financial leverage each firm has

Question

Quizplus · Accepted Answer

During the upswing of the business cycle, the economy is growing, which typically means that there is more demand for goods and services. A firm with high combined leverage (both operating and financial leverage) is likely to benefit more from an increase in sales because it can spread its fixed costs over a larger sales volume, leading to higher profit margins and earnings per share (EPS). On the other hand, a firm with low combined leverage may not be able to take advantage of the upswing as much because it has fewer fixed costs to spread. Therefore, Firm A is likely to show the best growth in EPS over the next year.

If the Business Cycle Is Just Beginning Its Upswing, Which