If the business cycle were 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

When the business cycle is at the beginning of its upswing, firms with high combined leverage tend to outperform those with low combined leverage. This is because as the economy starts growing, sales increase and firms with high leverage are able to magnify their earnings per share (EPS) due to their fixed financing costs. On the other hand, firms with low leverage don't have the same magnification effect and may see more modest earnings growth. Therefore, Firm A is likely to show the best growth in EPS over the next year.

If the Business Cycle Were Just Beginning Its Upswing, Which