Final answer:
Statements 1 and 2 are correct, indicating high operating gearing increases both the sensitivity of profits to activity volume and the riskiness of operations. Operating gearing affects a company's earnings volatility due to the proportion of fixed costs. Businesses must manage operations for both short-term and long-term sustainability, including financial structuring.
Step-by-step explanation:
The correct statements are both 1. High Operating gearing makes profits more sensitive to changes in the volume of activity, and 2. High Operating gearing makes the operations of a business more risky. So, the correct answer to the student's question is A. 1 and 2. Operating gearing, also known as operating leverage, refers to the proportion of fixed costs in a company's cost structure. A high operating gearing means that a company has a high proportion of fixed costs relative to variable costs, which implies that as volume of sales increases, profits will increase more than proportionally. However, if sales volume decreases, the profits will also decrease more than proportionally, making earnings more volatile and therefore riskier.
Businesses indeed operate in both the short run and the long run, with different financial strategies applicable for each timeframe. In the short run, businesses concentrate on immediate operational issues, while in the long run they focus on strategies for future viability and growth such as reinvestment or securing financial backing from investors like venture capitalists. Businesses operating in the long run will consider their capital structure, whether to issue bonds or stock, and may seek the involvement of venture capitalists to gain additional expertise and financial support.