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If, for a given level of activity, a firm’s ratio of variable costs to fixed costs were to fall
and, at the same time, its ratio of debt to equity were also to fall, what would be the
effect on the firm’s financial and operating risk?answer is financial risk decrease and operating risk increase .. can u plz explain how it is?
Financial risk is measured by the gearing ratio. If the ratio of debt to equity falls then the gearing is lower and there is less financial risk.
Operating risk is measured by the relative levels of variable and fixed costs. A lower ratio of variable to fixed costs means higher fixed costs which means more operating risk.
I explain both types of risk in great detail (with examples) in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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