Business risk refers to the relative dispersion of the firm’s earnings available to common stockholders.
To calculate the relative dispersion of a firm's earnings available to common stockholders, we need to look at its business risk. Business risk refers to the risk that a company's operations, market conditions, and other factors may significantly impact its financial performance and earnings.
Here are some steps to calculate the relative dispersion of a firm's earnings:
1. Gather financial information: Start by collecting the firm's financial statements, including their income statement and balance sheet. These documents provide details about the company's revenue, expenses, assets, liabilities, and equity.
2. Calculate earnings available to common stockholders: Determine the firm's net income after tax and preferred dividends. This figure represents the amount of earnings available to common stockholders.
3. Calculate the mean: Find the average earnings available to common stockholders over a specific period, such as a year. Sum up the earnings available to common stockholders for each period and divide by the number of periods.
4. Calculate the standard deviation: Standard deviation measures the dispersion of a dataset. Calculate the standard deviation of the earnings available to common stockholders over the same period. This will indicate the degree of variation or risk in the company's earnings.
5. Compare the standard deviation: Once you have the mean and standard deviation, compare the standard deviation to the mean. A higher standard deviation relative to the mean indicates higher dispersion or risk in the firm's earnings. On the other hand, a lower standard deviation indicates lower dispersion or risk.
By performing these calculations, you can evaluate the relative dispersion of a firm's earnings available to common stockholders, which provides insights into their business risk. Remember, this is just one aspect of evaluating a company's risk profile, and other factors should be considered when assessing overall risk.