Question

​(Business

and financial

risk​)

Which of the following sources of new earnings volatility demonstrates the effect of business versus financial risk​ (discuss the rationale for your​ decisions):

a. Amos Gooding Real Estate Company recently constructed a new office building and borrowed 100 percent of the money needed to fund the project.

b. Clearing House Outsourcing has historically paid a printer to prepare all of its printed documents.​ However, last year the firm acquired its own printing press​ (paying cash).

c. Smithers Enterprises has been a specialty retail shop that sells outdoor camping equipment. The firm recently decided to purchase a golf course.

a. Amos Gooding Real Estate Company recently constructed a new office building and borrowed 100 percent of the money needed to fund the project.

The fact that the firm borrowed​ 100% of the cost of the new investment suggests that the​ firm's

▼

business

financial

risk has risen.  ​(Select from the​ drop-down menu.)

b. Clearing House Outsourcing has historically paid a printer to prepare all of its printed documents.​ However, last year the firm acquired its own printing press​ (paying cash).

In this instance an outsourcing firm has entered into a new business related to printing.​ Also, the firm paid cash for the asset acquisition. One might think that the​ firm's

▼

business

financial

risk may have changed.  ​(Select from the​ drop-down menu.)

c. Smithers Enterprises has been a specialty retail shop that sells outdoor camping equipment. The firm recently decided to purchase a golf course.

It would appear that this firm may have changed its overall

▼

financial

business

risk since the firm was a specialty retailer and now combines this business with that of a golf course.  ​(Select from the​ drop-down menu.)

Answer 1

The business risk of an organization refers to the risk that company will not able able to make profits from the business operations and may end up making losses. While financial risk refers to the risk of non payment by company of its debt obligations on time. Based on these definition, the answers to the above questions is as follows:

a. The fact that firm has borrowed 100% of the funding requirement through debt, it has increased the financial risk of the company because the debt that needs to be paid back is higher and if the operations does not generate enough cash then it will not be able to repay debt.

b. In this case, the company has ventured into a new business of printing, that means that the firm has increased its business risk because the new business is out of the expertise of organization and may have potential risks in its management. However, since the payment is made through cash fully, no financial risk will arise for the company.

c. In this case as well, smithers enterprises has entered into a business which is different from its core business of which the management expertise may not be there with the current management of the company, therefore it is a case of a enhancement in the overall business risk of the organization in the longer run.