Question

1-What is the basic relationship between risk and return and how is this reflected in the value of the firm’s stock? The cost of debt?

2-What are the primary factors that should be considered when establishing a firm’s capital structure?

3-What are the primary differences and/or similarities between financial risk and business risk?

Answer 1

1. Risk and return both are related to each other which means higher the risk more will be return.Return is the reward for bearing risk.Various models in valuation of firms consider the amount of risk taken by firm and it's corresponding reward.Risk is reflected in terms of Beta and also various other model used for Valuation of stock.Market risk affects the cost of capital and which directly affects of the cost of debt of the company.Cost of debt is calculated while calculating WACC of the company which means that WACC changes with change is risk thus it affects cost of debt.Reference https://www.investopedia.com/ask/answers/043015/how-does-market-risk-affect-cost-capital.asp

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/risk-and-return/

2. Following primary factors should be considered when establishing firm's capital structure :-

i) Cash flow position of the company.

ii) Cost of debt and equity.

iii) Tax rate prevailing.

iv) Return on Investment and flotataion cost.

v) Interest coverage ratio and debt service coverage ratio.

3. Financing and Business risk are two different types of risk which must be considered by investor before Investing.Financiql risk is the company's ability to manage it's debts and business risk refers to company ability to generate sufficient revenue to cover it's operational expenses.

Financial risk is the risk related to the use of debt rather than making the company a profitable enterprise.Financial risk is concerned with the cost of financing while operational risk is concerned with cost of meeting other expenses.Busniss risk cannot be minimized whereas financial risk can be minimized by incorporating debt.

Both risk is faced by the investor of the company and both can be managed by business.Both is the indicator of level of risk faced by company.

Reference :-

https://www.investopedia.com/ask/answers/062315/what-are-key-differences-between-financial-risk-and-business-risk-company.asp