The two firms have the same level of total assets and expected net operating pro
ID: 2792848 • Letter: T
Question
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 Lost Pigeon's and Purple Tiger's major attributes: Lost Pigeon Total assets Total debt Expected NOPAT Standard deviation of expected NOPAT Purple Tiger Manufacturing Inc. Production Inc. $4,800,000 $2,160,000 $1,152,000 $206,400 $4,800,000 $1,104,000 $1,152,000 $321,600 Use the given financial data to indicate which firm has the higher degree of each type of risk. Which firm has more financial risk? Which firm has more business risk? O Lost Pigeon O Purple Tiger O Lost Pigeon O Purple TigerExplanation / Answer
Financial risk = Total debt/total asset
Lost pigeon :
Financial risk = 1,104,000/4,800,000
Financial risk = 0.23
Purple Tiger :
Financial risk = 2,160,000/4,800,000
Financial risk = 0.45
Purple Tiger has higher financial risk.
Financial risk: A company's financial risk, however, takes into account a company's leverage. If a company has a high amount of leverage, the financial risk to stockholders is high - meaning if a company cannot cover its debt and enters bankruptcy, the risk to stockholders not getting satisfied monetarily is high.
For business risk, we will compare standard deviation of expected NOPAT. Higher the standard deviation higher is the risk involved.
Lost Pigeon has higher business risk than Purple Tiger.
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