A combination of business risk and financial risk shows the risk of an organization’s future return on equity. Business risk is related to make a firm’s operation without any debt whereas financial risk requires that the firm’s common stockholders make a decision to finance it with debt. Business risk can be evaluated volatility in earnings and profits (coefficient of variation of returns on assets and of operating profits). A measure of business risk is also asset beta or unlevered beta. In case of AHP, it is 1.2 (βa) which is very low signifying low business risk for the firm.
AHP’s business risk is low mainly because: 1. It has been operating on four main lines of business that bear …show more content…
To calculate debt tax shield, the first step is to set the rating of company bond under three capital structures. Here we make a sensitive analysis, using the interest rate of different rating and get the interest coverage. (Exhibit 3)
Exhibit 3 Debt to Total Capital Ratio | 30% | 50% | 70% | Total Debt | 376.1 | 626.8 | 877.6 | | int. | int. cov. | int. | int. cov. | int. | int. cov. | AAA | 50.10 | 18.41 | 83.49 | 11.05 | 116.90 | 7.89 | AA | 51.98 | 17.74 | 86.62 | 10.65 | 121.28 | 7.60 | A | 52.92 | 17.43 | 88.19 | 10.46 | 123.48 | 7.47 | BBB | 66.08 | 13.96 | 110.13 | 8.37 | 154.19 | 5.98 | BB | 73.60 | 12.53 | 122.66 | 7.52 | 171.75 | 5.37 | B | 81.12 | 11.37 | 135.20 | 6.82 | 189.30 | 4.87 |
The interest coverage of AHP is significantly higher than that of bonds with different ratings, which also indicate its good business performance and plenty cash flow. After comparison, we could set the rating of AHP’s bond as following.(Exhibit 4) Considering the Debt Ratio in rating standard, which is much lower than that of AHP, the rating of AHP’s bond should be lower if more prudential. Thus, we will use the lower rating when calculate the interest and other figures.
Exhibit 4 Debt to Total Capital Ratio | 30% | 50% | 70% | proper rating | AAA | AAA\AA | AA\A |
The second step is to obtain the