For each of the following scenarios, explain whether the situation describes fin
ID: 2786959 • Letter: F
Question
For each of the following scenarios, explain whether the situation describes financial risk or business risk. Explain your answers to each scenario using at least one of the references from the background readings:
A pharmaceutical company has developed a new cancer treatment drug that has a much higher success rate than other drugs currently in the market. It has the potential to triple the company’s profits. However, the FDA has expressed concern about some side effects, and it is not clear if the FDA will approve the drug.
An airline has an EBIT of $100 million per year. However, it also has a huge amount of debt and pays $97 million per year in interest. Its EBIT is relatively stable but tends to go up or down by $5 million or so each year depending on the economy.
A basketball franchise earns an EBIT of $50 million a year when its team has a winning year. However, it earns only $10 million when its team has a losing year.
Explanation / Answer
Financial risk is type of risk thta arise becasue of excess use of debt in capital structure. Businsess risk is any risk affect the net income of the company. example of busienss risk is Increase in competition, change of consumer preference, political chnages, increase in cost of raw materia, labor strike etc.
a.
A pharmaceutical company has developed a new cancer treatment drug that has a much higher success rate than other drugs currently in the market. the drug has potential to increase profit of company but if FDA concern about te product then comapny cannot produce product.
This is an example of business risk.
b.
An airline has an EBIT of $100 million per year. However, it also has a huge amount of debt and pays $97 million per year in interest. becaus of excess debt, the chance of bankruptcy of company increase and so this is an example of financial risk.
c.
A basketball franchise earns an EBIT of $50 million a year when its team has a winning year. However, it earns only $10 million when its team has a losing year.
This is an example of business risk.
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