Operating Leverage Example Consider firms A, B and C, all operating in the same industry and 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 $0.50 per unit. Firm C has even lower fixed costs than firm A; its fixed costs are $ 2 million and variable costs are $1.50 per unit. Given the table below showing how the firms perform in different economic scenarios, compute and compare the degree of operating leverage for the 3 firms when the economy moves from a normal growth to a recession. Recession Normal A B B 5 5 6 6 6 $2 $2 $2 $2 10 5 $2 10 8 10 12 Sales (million units) Price per unit Revenue ($ million) Fixed Costs ($ million) Variable Costs ($ million) Total costs ($ million) Profits ($ millions) 12 $2 12 2 5 2 5 8 5 2.5 6 3 9 7.5 9.5 10.0 10.5 11.0 11.0 11.0 0.0 -0.5 0.5 1.0 1.0 1.0