What is business risk? What is financial risk? Suppose Firm A has greater business risk than Firm B. Is it true that Firm A also has a higher cost of equity capital?
"Business risk is the equity risk arising from the nature of the firm's operating activity, and is directly related to the systematic risk of the firm's assets. Financial risk is the equity risk that is due entirely to the firm's chosen capital structure. As financial leverage, or the use of debt financing, increases, so does financial risk and, hence, the overall risk of the equity. Thus, Firm B could have a higher cost of equity if it uses greater leverage."