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Concept And Meaning Of Business Risk

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Business risk is defined as the riskiness on the firm's stock provided that the firm has used no debt capital. It is the risk inherent in operation of the business. A firm's business risk arises because of uncertainty associated  to projection of return in invested capital (ROIC). ROIC is calculates as below.

ROIC = NOPAT/Capital

In this equation, NOPAT is the net operating profit after tax, which is calculated as net income available to common stockholders plus after-tax interest payment. Capital includes both debt and equity. We assume for simplicity that the firm has used no preferred stock capital. If a company uses no debt capital, its interest expenses will be zero and the capital consists only common equity. Therefore, return on invested capital with zero debt os calculated as below.

ROIC = Net income/Common equity

This equation gives same result as to that of return on equity (ROE), if company has used debt capital, In such a case, the business risk is simply indicated by standard deviation, which measures the variability associated to firm's ROE assuming no debt financing used.

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