Final answer:
Firm A, with high combined leverage, is likely to show the best growth in EPS during an economic upswing, due to the potential for magnified profit growth. However, this comes with higher risk if the economic conditions do not pan out as expected.
Step-by-step explanation:
If the business cycle is just beginning its upswing, it is likely that the firm with high combined leverage, Firm A, would show the best growth in Earnings Per Share (EPS) over the next year. High combined leverage means that the firm has a higher level of fixed costs in both operations (operating leverage) and financing (financial leverage). During an economic upswing, sales and revenues typically increase, which can lead to a magnified increase in EPS for a highly leveraged firm if it operates above its break-even point. On the other hand, Firm B, with low combined leverage, would have less volatile EPS, but also less potential for magnified growth during an economic upswing.
It's important to note that with high leverage, there is also a higher risk. If the upswing were not as strong as anticipated or turned down again, Firm A could potentially suffer much larger declines in EPS than Firm B, due to its higher fixed costs. In summary, higher leverage amplifies outcomes, both positive and negative.