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Explain two types of risks: business and financial risks. How to measure them (DOL, DFL, and...

  1. Explain two types of risks: business and financial risks. How to measure them (DOL, DFL, and DTL)? Explain the following: leverage effect, business risk, financial risk, and total risk.

The operating leverage is because of ________________________, and it is measured by ________________(formula).

The financial leverage is because of _________________________, and it is measured by ________________(formula).

The total leverage is because of ____________________________, and it is measured by ________________(formula).

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Answer #1

Answer: Financial Risk refers to the Companies ability to manage its debt where business risk covers the Companies ability to generate revue for operational expenses.

Leverage effect is the difference between ROE and ROCE. It tells us how you can earn more return on equity exceeding return on capital employed.

Under Total Risk, we try to ascertain all the risks associated in taking a specific course of action. Be it business risk or financial risk.

1. The operating leverage is because of fixed operating costs and its formula is ( % change in EBIT / % Change in sales)

2. The financial leverage is because of Long Term Debt and its formula is ( % change in EPS / % Change in EBIT)

3. The Total leverage is because of Operating and financial leverage and its formula is ( % Change in EPS / % Change in Sales)

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