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Business and Financial Risk of Assets

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Understanding Business and Financial Risk
The two firms have the same level of total assets and expected net operating profit after tax (NOPAT)
But they differ on two critical characteristics: Total Debt and standard deviation of expected NOPAT. The information below outlines some of the Company A and Company B characteristics.
Company A: Company B
Total Assets $5,200.00 $5,200.00
Total Debt $1,196,000 $2,340.00
Expected NOPAT $1,248.00 $1,248.00
Standard Deviation of expected NOPAT $348, 00 $223,600
Which Company has more Business Risk?
Which Firm has more financial Risk?
2. Project will require 400,000 in assets
. The Project is expected to produce an EBIT of 50,000.
. The project will be financed with 100% equity
. There will be 25,000 shares of common equity outstanding
. The company faces a tax rate of 30%
3.What will the ROE for this project? A. 8.31% B. 7.44%, C. 8.75% D. 7.00%
4.What will the EPS will be if finances the project with 100% equity? $1.12,1.47,1.33,1.19,1.40
5.Same Project is being financed with 50% debt and 50% equity. The interest rate on the debt will be 13%. Only 50% of project is financed with equity, it will only have 12,500 shares outstanding. What will be the ROE on this project if the company decides to finance with 50% debt and 50% equity?
a. 8.40%
b. 8.82%
c. 9.66%
d. 10.08%

6. What is the EPS? $1.61, 1.47, 1.07,1.27,1.347. Using this financial leverage will _______________projects ROE
a. Increase
b. decrease

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The business and financial risks of assets are examined.

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Answer:
Given that,
Company A Company B
Total Assets $5,200.00 $5,200.00
Total Debt $1,196.00 $2,340.00
Expected NOPAT $1,248.00 $1,248.00
Standard Deviation of expected NOPAT $348.00 $223.60

Therefore,
Business Risk for Company A=$348.00/$1,248.00=0.28
Business Risk for Company ...

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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