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 False True 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 fim 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 retum eamed 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. Both statements are correct. Only Statement 1 is correct. Neither statement is correct. As an analyst, Olivia is comparing two nearly identical manufacturing firms: Blue Strawberry Manufacturing Company and Orange Snail Production Inc. It is your job to evaluate the relative business and financial risks of Blue Strawberry and Orange Snail. The two firms possess the same value of total assets, and eam 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 Blue Strawberry's and Orange Snail's major attributes: Total assets Blue Strawberry Manufacturing Orange Snail Production (Dollars) (Dollars) 4,800,000 4,800,000 1,104,000 2,160,000 1,152,000 1,152.000 321,600 206,400 Total debt Expected EBIT Standard deviation of expected IT Use the given financial data to indicate which firm has the higher degree of each type of risk. Which firm has more business risk? Blue Strawberry Orange Snail Which firm has more financial risk? Blue Strawberry Orange Snail