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Sir the statement that business risk is assumed to be constant as capital structure changes, this statement only applies to traditional theory of gearing OR does it also applies to other theories i,e M and M theory and Pecking order theory?
All the theories of gearing are only looking at the effect of changes in the level of gearing for a company. They are looking at different levels of gearing for the same company and therefore only look at the gearing effect – given we are talking about the same company then the business risk will automatically stay the same.
It is CAPM that deals with changes in the business risk. If both gearing and business risk change, then we need to use the asset beta formula, which comes from M&M. In this situation (for the exam) other theories of gearing are of no relevance.
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