Explain what is meant by business risk and financial risk using MM capital structure theory.
Business risk is the uncertainty surrounding expected operation cash flows, that is, the earnings before interest and tax. The risk depend on business factors such as competition operating leverage, correlation between the firm and the economy, degree of diversification among other factors.
Financial risk, on the other hand, is additional uncertainty with regards to common shareholders resulting from the use of financial leveraged. The degree of the risk depend amount of debt used and preferred stock financing.