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FM
FM
David Durand.
INCOME
● The theory suggests increasing value of
APPROACH the firm by decreasing the overall cost of
capital which is measured in terms of
Weighted Average Cost of Capital
through higher debt proportion.
● Increasing the D/E ratio reduces costs.
The increase in debt will not affect
ASSUMPTIONS
●
the confidence levels of the investors.
EBIT = 100,000
INCOME
APPROACH ● Acc. to this theory, the total market value of
the firm is not affected by the change in the
capital structure and the overall cost of capital
remain constant irrespective of debt-equity
ratio
● The market capitalizes the value of the
firm as a whole. Thus, the split between
debt and equity is not important
ASSUMPTION
OF NET ● The cost of debt is lower than cost of
OPERATING equity
INCOME
The risk perception of the investor is not
APPROACH ●
changed by the use of debt
Taxes - - -