Net Operating Income Approach Given By 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 NI Approach Suggested By David Durand in 1959 The earning of the firm after the payment of all other expenses except interest on debt is called Net Operating Income NOI and the earning available for equity shareholders after the payment of interest is called as Net Income NI According to Net Income Approach a change in the financial leverage of a firm will lead to a corresponding change in the Weighted Average Cost of Capital WACC and the company s value The Net Income Approach suggests that with the increase in leverage proportion of debt the WACC decreases and the firm s value increases
Net Operating Income Approach Given By
Net Operating Income Approach Given By
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Net Income Approach Capital Structure With Assumptions Examples
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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 For a given level of Earnings before Interest and Taxes EBIT the value of a firm would be equal to EBIT overall capitalization rate Assumptions of the Net Operating Income Approach NOI 1 The firm is evaluated as a whole by the market Accordingly overall capitalization rate is used to calculate the value of the firm
Net Operating Income or EBIT Overall Cost of capital Ko If we are given value of a firm and its operating income then we can cal culate its overall cost of capital as below Ko Net Operating Income or EBIT V 7 4 Net Income Approach As per Net Income Approach there is a relationship between capital structure The Net Operating Income NOI approach provides a compelling perspective on the relationship between capital structure and firm value suggesting that the choice between debt and equity financing does not impact the overall value of the firm or its cost of capital By understanding the theoretical underpinnings assumptions and implications
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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 The total assets of both the companies A and B are same i e Rs 30 00 000 on which each company earns 20 return Find the value of each company and overall cost of capital using net operating income NOI Approach Equity capitalisation rate for B Ltd is 15 The tax rate is 50 Solution NOI Approach with Taxes
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Net Operating Income Approach Given By - 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