1. Based on Case Exhibit 1, how much business risk does Hill Country face? Think low, medium, high. Be specific by referencing the appropriate financial indicators to support your argument.

Business risk Hill Country’s operating strategy was efficiency and controlling costs. Hill Country facing off against larger companies like PepsiCo. Efficient operations and tight cost controls were necessary conditions for success. Hill Country’s culture and managerial philosophy was caution and risk aversion. The culture of risk-avoidance was also manifested in its financing decisions. Business risk is the riskiness of the firm’s assets if no debt is used. Efficiency and controlling strategy decrease the firm’s business risk. This strategy reduced input cost and make the firm could not fluctuated by market sale price. Business risk is tied to a company's fixed costs. Fixed costs always must be paid, no matter what the company's income. The higher the level of a company's fixed costs, the higher the business risk. 1) Degree of Operating Leverage (DOL) We use the operating leverage to measure how much income will change in a percentage change in sales volume. The more fixed assets the firm has, the more the change will be. DOL = % change∈EBIT /% change∈Sales Hill Country Snack Foods Company (in millions) . 2011. 2010 % Change EBIT $151.3. $126.7. 19.42% Sales $1,364.6 $1,261.7. 8.16% Degree of Operating Leverage 2.3799 A company with a high degree of operating leverage has high fixed costs relative to its variable costs. If the degree of operating leverage is high, the earnings before interest and taxes (EBIT) experiences volatility with respect to a percentage change in sales, all else remaining the same, and vice versa. If the DOL is equal to 1, that means that the firm has no fixed costs. All costs are variable and a 20% change in sales volume will mean a 20% change in income. But, Hill Country introduce lower fixed costs into the picture and it rise above 1 which is 2.3799 of DOL, then the company has operating leverage. In addition, Hill Country is price taker in the market that is increase in prices is not one of the choices it can implement. Also, since its profitability relies heavily on cost management, an intense competition can worsen the situation of Hill Country in the future. Cost management link to the bargaining power of Hill Country over its suppliers. Whenever their suppliers have more bargaining power, Hill Country would face a potential decline in its profit margin. Macroeconomics conditions can contribute to the business risk of Hill Country. Financial risk at each of the three-alternative debt-to-capital ratios Financial risk is the possibility that shareholders will lose money when they invest in a company that has debt. It is the general term for many different types of risks related to the finance industry. These include risks involving financial transactions such as company loans, and its exposure to loan default. The term is typically used to reflect an investor's uncertainty of collecting returns and the potential for monetary loss. A pro forma financial analysis is presented in Exhibits 4 and 5, which was prepared to address speculation about how a change to Hill Country’s capital structure would affect its financial results. Exhibit 4 shows the company’s actual 2011 financial results and pro forma restatement of 2011 results under three alternative capital structures: 20% debt-to-capital, 40% debt-to-capital, and 60% debt-to-capital. A large debt-to-capital ratio are indicating that equity holders are making extensive use of debt and making the overall business riskier. Financial risk is briefly assessed using interest coverage ratios where is the company only starts facing significant financial risk on 60% of Debt-to-Capital ratio by 4.52. At levels 20% and 40% the company is still able to maintain a healthy coverage ratio at 36.9 and 11.82 respectively, which is still superior to its competitors, Snyder and Pepsi at 6.67 and 11.25 respectively. This ratio indicates the degree of protection available to creditors by measuring the extent to which earnings available for interest covers required interest payments. 2) Degree of Financial Leverage The financial leverage ratio measures the amount of debt held by the business firm that they use to finance their operations. Debt creates additional business risk to the firm if income varies because debt must be serviced. In other words, if a firm uses debt financing, they must pay interest on the debt no matter what their income. DFL = Operating Income(EBIT ) /Net Income Hill Country Snack Foods . Actual 2011. 20%Debt-to Capital. 40%Debt-to Capital. 60%Debt-to capital Operating $151.3. $151.3. $151.3. $151.3 Income(EBIT) Net Income. $97.6. $94.9. $89.3. $76.0 Financial Leverage. 1.5502. 1.5943. 1.6943. 1.9908 The financial leverage ratio measures that effect on the business firm. We can also say that it measures the financial risk of the business firm. The conclusion is the higher the leverage ratio is, the higher the risk level will be.

1. Based on Case Exhibit 1, how much business risk does Hill Country face? Think low, medium, high.

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