Net Operating Income Approach Of Capital Structure Example The Net Income Approach suggests that the value of the firm can be increased by decreasing the overall cost of capital For example vis vis the equity debt mix of 50 50 if the equity debt mix changes to 20 80 it would positively impact the value of the business and increase the value per share Capital Structure Theory Net
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 or EBIT V 7 4 Net Income Approach As per Net Income Approach there is a relationship between capital structure and value of the firm and therefore firm can affect its value by increasing or decreasing the debt proportion in the overall financing mix This approach shows that capital structure has relevance in determining
Net Operating Income Approach Of Capital Structure Example
Net Operating Income Approach Of Capital Structure Example
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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 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
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 7 5 Capital structure Theories 7 5 1 Net Income approach 7 5 2 Net operating income approach 7 5 3 The Traditional View 7 5 4 Modigliani Miller hypothesis 7 6 Summary For example one company may give more importance to flexibility to conservatism and another company
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NET INCOME THEORY DAVID DURAND According to this theory capital structure decisions are relevant tothe value of firm An increase in proportion of debt i e the degree of financial leverage will lead todecline in the form scost of capital while the value of firm and market price of equity shares will increase and vice versa This document discusses the Net Operating Income Approach to capital structure theory It states that according to this approach the value of a firm is not affected by changes in the debt component of its capital structure While increasing debt raises bankruptcy risk it also increases required equity returns as compensation The approach assumes the overall capitalization rate and weighted
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