Most Correct Statement

B

Financial risk is an increase in stockholders' risk, over and above the firm's basic business risk, resulting from the use of financial leverage, which refers to the use of fixed-income securities.

Let's go through each statement and evaluate its correctness:

A. The statement suggests that a firm's business risk is influenced by both industry characteristics and economic conditions. This is generally true. Industry characteristics, such as competition, regulatory environment, and market conditions, can affect a firm's risk profile. Economic conditions, such as inflation, interest rates, and overall market stability, can also impact a firm's business risk. However, the statement also claims that these factors are not subject to any degree of managerial control, which is incorrect. While managers may not have complete control over industry or economic conditions, they can take actions to mitigate or adapt to these risks. Therefore, this statement is not entirely correct.

B. The statement suggests that a firm's financial risk consists of both market risk and diversifiable risk components. This statement is generally correct. Financial risk refers to the risk of a firm's inability to meet its financial obligations. Market risk is the risk associated with overall market movements, such as changes in interest rates or exchange rates, which can affect a firm's financial position. Diversifiable risk, also known as specific risk, is the risk that can be reduced through diversification, such as risks specific to a particular industry or company. Therefore, this statement is correct.

C. The statement claims that when a firm is at or near its target capital structure, financial flexibility becomes less important. This statement is incorrect. Financial flexibility refers to a company's ability to access capital quickly and at reasonable costs. Even when a firm is at its target capital structure, maintaining financial flexibility remains crucial. Unforeseen events, changes in business conditions, or growth opportunities may require additional capital or adjustments to the capital structure. Therefore, this statement is false.

D. The statement suggests that a firm's business risk is solely determined by the financial characteristics of its industry. This statement is incorrect. While financial characteristics of an industry, such as profit margins, volatility, and capital intensity, can influence a firm's business risk, it is not the sole determinant. Business risk can also be influenced by factors like competition, technological advancements, regulatory changes, and managerial decisions. Therefore, this statement is false.

E. The statement claims that all of the statements are false. As we have analyzed, statement B is correct, while statements A, C, and D are incorrect. Therefore, this statement is false.

In summary, the correct answer is B. The firm's financial risk may have both market risk and diversifiable risk components.