Which of the following statements about business risk and financial risk is least accurate? A) Factors that affect business risk are demand, sales price, and input price variability. B) The greater a company’s business risk, the higher its optimal debt ratio. C) Financial risk is the additional risk borne by the common stockholders as a result of the decision to use debt. D) Business risk is the riskiness of the company’s assets if it uses no debt. Your answer: C was incorrect. The correct answer was B) The greater a company’s business risk, the higher its optimal debt ratio. The greater a company’s business risk, the lower its optimal debt ratio. ************ I thot finance risk means that if you have more debt in ur captial structure, the higher the risk. So higher Debt = higher debt ratio?
Total Risk = Business Risk + Financial Risk But the two components (Business Risk and Financial Risk) are not correlated. Optimally companies would want to keep there risks lower. So if Business risk is high, optimally the Financial Risk should be low. Hence B.
The problem here is with the word optimal. I am not sure it is used correctly, but a company with wild earnings and sales numbers (business risk) should not take a high financial risk (i.e., too much debt). In other words, creditors would not accept a high financial risk for this company. Dreary
In academic wacc discussions, wacc increases with leverage until bankruptcy costs begin to dominate. As business risk increases, bkrpt risk increases, so the point of minimum wacc occurs at lower leverage.