Given below are two statements:
Assertion (A): If the business risk of a firm is lower, its capacity to use debt is higher.
Reason (R): Business risk depends upon the fixed financing costs of a business.
In the light of the above statements, choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → (A) is true but (R) is false.
Assertion (A): If the business risk of a firm is lower, its capacity to use debt is higher. — True. A firm with low business risk has steady operating results. So it can take on more debt and still meet the interest and repayments.
Reason (R): Business risk depends upon the fixed financing costs of a business. — False. Business risk, also called operating risk, depends upon fixed operating costs such as rent, insurance premium and salaries.
Fixed financing costs, such as interest on debt, decide the financial risk of a business.
NCERT (2026-27 Edition): “9. Risk Consideration: As discussed earlier, use of debt increases the financial risk of a business. Financial risk refers to a position when a company is unable to meet its fixed financial charges namely interest payment, preference dividend and repayment obligations. Apart from the financial risk, every business has some operating risk (also called business risk). Business risk depends upon fixed operating costs. Higher fixed operating costs result in higher business risk and vice-versa. The total risk depends upon both the business risk and the financial risk. If a firm’s business risk is lower, its capacity to use debt is higher and vice-versa.” |