Net Income Approach Of Capital Structure 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 to Capital Structure Theory David Durand first suggested this approach in 1952 and he was a proponent of financial leverage He postulated that a change in financial leverage 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 Income Approach Of Capital Structure
Net Income Approach Of Capital Structure
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3 Net Income Approach NI According to this approach capital structure decision is relevant to the value of the firm An increase in financial leverage Debt Proportion will lead to decline in the weighted average cost of capital WACC while the value of the firm as well as market price of ordinary share will increase 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
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 This section explains the Net Income Approach which posits that changes in the capital structure can influence the overall cost of capital and the firm s valuation It discusses the assumptions the impact of leverage on firm value and the practical applications of this approach in financial decision making
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The decrease in cost of capital in turn increases the value of the firm Thus when the proportion of debt is 100 in capital structure cost of capital is minimum And when there is no debt in capital structure the cost of capital is maximum What are the assumptions of Net Income Approach Along with the basic assumptions of Capital 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
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Net Income Approach Of Capital Structure - 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