A, B, OR C 1.) The chance that operating income declines due to increased compet

Question

A, B, OR C

1.) The chance that operating income declines due to increased competition is an example of increased...

2.) When your firm decreases the debt in its capital structure...

it will reduce its unlevered beta.

it will reduce financial risk.

it will reduce business risk.

3.) Show work please!

business risk. According to Morningstar, Cummins' current beta is 0.95. In addition: long-term debt = $1.6 billion . shareholders' equity = $6.9 billion · non-current assets = $3.8 billion . tax rate-32.0% What is an estimate for Cummins' unlevered beta? about 0.69 about 6.02 about 0.82

Explanation / Answer

Answer 1. Business Risk
The chance that the operating income declines due to increased competition is an example of business risk. Business risk is defined as the risk faced in terms of sales volume, competition, price, COGS ie input costs etc. When this factors influence and reduce company's profit is it called business risk.


Answer 2. Financial Risk
Financial risk is associated with the amount of loss the shareholders or investors can make by investing in the company which has debt. This may happen when the company is inadequate of its cashflow for paying debt. Thus reducing debt in the company will increase shareholders confidence as the repayment would be low from the available cash flow reducing risk.


Answer 3. Unlevered Beta = Beta / 1+(1-tax rate) * (debt/equity)
Thus from the question Beta = 0.95, Tax rate = 32%, debt = 1.6 billion and equity = 6.9 billion
Hence,
Unlevered beta = 0.95 / 1+(1-0.32) * (1.6/6.9)
= 0.95 / 1 + 0.68 * 0.2318
=0.95 / 1.1576
= 0.82

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