Net Operating Income Approach Of Capital Structure Assumptions As observed in the case of the Net Income Approach with an increase in debt proportion the total market value of the company increases and the cost of capital decreases The reason for this conclusion is the assumption of the NI approach that irrespective of debt financing in capital structure the cost of equity will remain the same
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 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
Net Operating Income Approach Of Capital Structure Assumptions
Net Operating Income Approach Of Capital Structure Assumptions
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5 Net Operating Income Approach NOI According to this approach capital structure decisions of the firm are irrelevant Any change in the leverage will not lead to any change in the total value of the firm and the market price of shares as the overall cost of capital is independent of the degree of leverage As per NOI Approach 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 part introduces the Net Operating Income Approach which suggests that the cost of capital and the firm value remain unaffected by changes in capital structure It covers the theoretical underpinnings assumptions and implications of this approach contrasting it with the Net Income Approach Reason when we increase the proportion of debt in the capital structure of the company the overall cost of capital decreases But at the same time the interest burden on the company increases When interest payments increase risk perception of the equity shareholders also increases and they start expecting higher returns from the company
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To compensate for the higher risk involved in investing in highly levered company equity holders naturally expect higher returns which in turn increases the cost of equity capital Assumptions of the Net Operating Income Approach NOI 1 The firm is evaluated as a whole by the market 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 Assumptions of Net Income Approach 1 Cost of equity is higher than
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Net Operating Income Approach Of Capital Structure Assumptions - This part introduces the Net Operating Income Approach which suggests that the cost of capital and the firm value remain unaffected by changes in capital structure It covers the theoretical underpinnings assumptions and implications of this approach contrasting it with the Net Income Approach