Assignment 13-Capital Structure and Leverage 4. Understanding business and finan
ID: 2658761 • Letter: A
Question
Assignment 13-Capital Structure and Leverage 4. Understanding business and financial risks The total nsk in a firm is determined by evaluating the firm's business nsk and financial risk. As Aa As an analyst, Olivia is comparing two nearly identical manufacturing firms: Happy Turtle Manufacturing Companry and Orange Snail Production Inc. It is your job to evaluate the relative business and financial risks of Happy Turtle and Orange Snail. The two firms have the same level of total assets and expected net operating profit after taxes (NOPAT), but they differ in two critical characteristics: total debt and the standard deviation of the expected NOPAT. The following table outlines some of Happy Turtle's and Orange Snail's major attributes: Total assets Total debt Expected NOPAT Standard deviation of expected NOPAT Happy Turtle Orange Snail Manufacturing Inc. Production Inc $5,200,000 $1,040,000 $1,248,000 $223,600 $5,200,000 $2,600,000 $1,248,000 348,400Explanation / Answer
Business Risk = Standard Deviation of expected NOPAT/Expected NOPAT Happy Turtle Orange Snail Standard deviation of expected NOPAT 348400 223600 Expected NOPAT 1248000 1248000 Business Risk 27.92% 17.92% Happy Turtle has more business risk Debt Ratio = Total assets/Total debt Happy Debt Orange Snail Total assets 5200000 5200000 Total Debt 2600000 1040000 Debt Ratio 2 5 Orange Snail has more financial risk due to higher debt