Question

Identify the statement that is incorrect. The debt ratio is one measure of financial risk. Lower financial leverage involves lower risk. Higher financial leverage involves higher risk. Risk is higher if a company has more liabilities. Risk is higher if a company has more assets.

Answer 1

Answer:

Risk is higher if a company has more assets is incorrect.

Explanation:

In analyzing the options, the statement that debt ratio is one measure of the financial risk is correct because the debt ratio measures the proportion of company`s capital that is owned to outsiders who might pursue legal action if interest and repayment is not made. Because of this legal obligation to  repay lenders and the huge interest burden, debt ratio helps to measure financial risk of the firm.

Statement that lower financial leverage involves lower risk is also correct, because it means majority of the firm assets are financed by equity owners and not outsiders and the firm has a lower interest burden. In contrast, higher financial risk involves higher risk for the same reason of higher interest burden and risk of repayment of loan.

Statement that risk is higher if company has more liabilities is also correct. Huge liabilities can make company to be insolvent and eventually leads to liquidation of the company.

The last statement that risk is higher if a company has more assets is incorrect because assets provide economic benefits in which the company can use to generate sales and derive funds. So having more assets does not make the entity`s risk to be higher.