3. Understanding business and financial risks The total risk in a firm is determined by evaluating the firm's business risk and financial risk. True or False: All other things being equal, firms exhibiting high degrees of operating leverage exhibit lower levels of business risk. True False The use of financial leverage, or fixed-cost sources of capital, Involves a trade-off between its effect on the firm's shareholders and its effect on the riskiness of the firm Statement 1 In general, the more business risk that a firm experiences, the more financial leverage the firm will want to employ in its capital structure Statement 2 When its earnings are decreasing, the use of greater levels of debt capital in a firm's capital structure magnifies the negative return earned by the firm's shareholders beyond that earned by the shareholders of an otherwise identical unlevered firm. Statement 1 In general, the more business risk that a firm experiences, the more financial leverage the firm will want to employ in its capital structure Statement 2 When its earnings are decreasing the use of greater levels of debt capital in a firm's capital structure magnifies the negative return earned by the firm's shareholders beyond that earned by the shareholders of an otherwise identical unlevered firm. Indicate the correct statement. Only Statement 2 is correct. O Both statements are correct. Only Statement 1 is correct Neither statement is correct As an analyst, Olivia is comparing two nearly identical manufacturing firms: Happy Turtle Manufacturing Company and Teal Camel Production Inc. It is your job to evaluate the relative business and financial risks of Happy Turtle and Teal Camel The two firms possess the same value of total assets, and earn identical levels of expected operating profit (as measured by the firms' earnings before interest and taxes, or EBIT), but they differ in two critical characteristics: their amount of total debt and the standard deviation of their expected EBIT The following table describes several of Happy Turtle's and Teal Camel's major attributes: As an analyst, Olivia is comparing two nearly identical manufacturing firms: Happy Turtle Manufacturing Company and Teal Comel Production Inc. It is your job to evaluate the relative business and financial risks of Happy Turtle and Teal Camel The two firms possess the same value of total assets, and earn identical levels of expected operating profit (as measured by the firms' earnings before Interest and taxes, or EBIT), but they differ in two critical characteristics: their amount of total debt and the standard deviation of their expected EBIT The following table describes several of Happy Turtle's and Teal Camel's major attributes: Total assets Total debt Expected EBIT Standard deviation of expected EBIT Happy Turtle Manufacturing Teal Camel Production (Dollars) (Dollars) 4,400,000 4,400,000 2,200,000 880,000 1,056,000 1,056,000 294,800 189,200 Use the given Ninancial data to indicate which firm has the higher degree of each type of risk Which firm has more business risk? Teal Camel Happy Turtle Which firm has more financial risk? Happy Turtle Teal Camel