Question

For each of the following scenarios, explain whether the situation describes financial risk or business risk. Explain your answers to each scenario using at least one of the references from the background readings:

A pharmaceutical company has developed a new cancer treatment drug that has a much higher success rate than other drugs currently in the market. It has the potential to triple the company’s profits. However, the FDA has expressed concern about some side effects, and it is not clear if the FDA will approve the drug.

An airline has an EBIT of $100 million per year. However, it also has a huge amount of debt and pays $97 million per year in interest. Its EBIT is relatively stable but tends to go up or down by $5 million or so each year depending on the economy.

A basketball franchise earns an EBIT of $50 million a year when its team has a winning year. However, it earns only $10 million when its team has a losing year.

Answer 1

a). This case indicates business risk as the case depicts that the overall business is affected if new cancer treatment drug is not passed by FDA.

b). This case indicates Financial risk as the case depicts that the company has huge amount of excess debt on the capital structure which leads to all of its earnings being paid as interest on debt.

c). This case indicates business risk because its earnings fluctuate from $50 million to $10 million which means that the winning and losing game will directly affect overall profitability of the business.