Question

I have two really quick ones from an exam review. A small explanation would be great!

Some of the factors that can affect business risk are:

Select one:

- Possible variations in the demand for the company’s product and/or in the product’s price per unit

- Possible variations in the cost of firm’s debt

- The firm’s leverage

- All of the above

Increasing firm’s leverage:

Select one:

- Results in higher business risk

- Increases tax subsidy on Fixed Assets´ depreciation

- Increases tax subsidy on debt

- Never affects the firm’s value

Answer 1

Some of the factors that can affect business risk are:

- Possible variations in the demand for the company’s product and/or in the product’s price per unit

- Possible variations in the cost of firm’s debt

- The firm’s leverage

- All of the above

Correct answer is - All of the above.

Business risk refers to the risk whether the company will be able to meet it's operational expenses. Demand of company's product or product's price per unit actually affects it's ability to generate revenue and eventually it's a business risk. If cost of the firm's debt increases, then interest expense also increase which increase the operational expense. So, it affects the business risk. And lastly, if the firm's leverage is too high then also it increases interest expense  and affects business risk.

Increasing Firm's Leverage- Results in higher business risk.

When the firm has high leverage, it has high debt. The interest is also high. Interest expense increases operational expenses. When operational expense increases,then obviously the business risk becomes higher.