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consider two firms operating in the same industry with identical revenues in all pha 665679

Operating Leverage

Consider two firms operating in the same industry with identical revenues in all phases of the business cycle: recession, normal, and expansion. Firm A has short term leases on most of its equipment and can reduce its lease expenditures when production slackens. It has fixed costs of $5 million and variable costs of $1 per unit of output. Firm B has long term leases on most of its equipment and must make lease payments regardless of economic conditions. Its fixed costs are higher, $8 million, but its variable costs are only $.50 per unit. Table 17.4 shows that Firm A will do better in recessions than Firm B, but not as well in expansions. A’s costs move in conjunction with its revenues to help performance in downturns and impede performance in upturns.

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