3 Explain The Net Income Approach And Net Operating Income Approach Of Capital Structure Net Operating Income Approach The net operating income approach suggested by David Durand states the irrelevance of capital structure in calculating the firm s value The cost of capital for the firm will always be the same No matter what the degree of leverage is the firm s total value will remain constant
This article throws light upon the top four theories of capital structure The theories are 1 Net Income Approach 2 Net Operating Income Approach 3 Traditional Approach 4 Modigliani Miller Approach Theory 1 Net Income NI Approach David Durand suggested the two famous capital structure theories viz Net Income Approach and the Operating Income Approach According to NI approach a Net Operating Income Approach NOI Approach This approach was put forth by Durand and totally differs from the Net Income Approach Also famous as the traditional approach Net Operating Income Approach suggests that the change in debt of the firm company or the change in leverage fails to affect the total value of the firm company
3 Explain The Net Income Approach And Net Operating Income Approach Of Capital Structure
3 Explain The Net Income Approach And Net Operating Income Approach Of Capital Structure
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3 The Traditional Approach The traditional approach also known as intermediate approach is a compromise between the two extremes f net income approach and net operating income approach According to this theory the value of the firm can be increase initially or the cost of capital can be decreased by using more debt as the debt is a cheaper source funds than equity Net Income approach of capital structure theory assumes that the only capital can affect the value of firm and overall cost of capital According to Net income theory proposed by David Durand in 1952 Capital structure is relevant to the value and overall cost of capital If firm uses debt as leverage weighted average cost of capital will
Net income approach and net operating income approach were proposed by David Durand According to NI approach there exists positive relationship between capital structure and valuation of firm and change in the pattern of capitalisation brings about corresponding change in the overall cost of capital and total value of the firm Thus with an increase Overlooks market fluctuations in capital costs Net Operating Income Approach NOI The net operating income approach asserts that the capital structure of a firm does not affect its value It contemplates that the market values a company on the basis of its operating income and risk Key Assumptions The cost of capital is constant
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2 Net Operating Income Approach NOI This approach is also suggested by Durand according to it the market value of the firm is not affected by the capital structure changes The market value of the firm is ascertained by capitalising the net operating income at the overall cost of capital which is constant 2 Net Operating Income Approach NOI Approach This theory is just opposite to NI approach NI approach is relevant to capital structure decision It means decision of debt equity mix does affect the WACC and value of the firm As per NOI approach the capital structure decision is irrelevant and the degree of financial leverage does not affect
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3 Explain The Net Income Approach And Net Operating Income Approach Of Capital Structure - Overlooks market fluctuations in capital costs Net Operating Income Approach NOI The net operating income approach asserts that the capital structure of a firm does not affect its value It contemplates that the market values a company on the basis of its operating income and risk Key Assumptions The cost of capital is constant