The document discusses how the net income approach suggests that a company's capital structure and leverage ratio can impact its value and overall cost of capital. Specifically, it states that if a company takes on more debt, which has a lower cost than equity, then its overall cost of capital will decrease, leading to an increase in the value of the firm and the market price of its shares. It lists some key assumptions, including that debt has a lower cost than equity and that investor risk perception is unchanged by debt levels. Finally, it includes a diagram showing the relationships between cost of equity, overall cost of capital, and cost of debt.
The document discusses how the net income approach suggests that a company's capital structure and leverage ratio can impact its value and overall cost of capital. Specifically, it states that if a company takes on more debt, which has a lower cost than equity, then its overall cost of capital will decrease, leading to an increase in the value of the firm and the market price of its shares. It lists some key assumptions, including that debt has a lower cost than equity and that investor risk perception is unchanged by debt levels. Finally, it includes a diagram showing the relationships between cost of equity, overall cost of capital, and cost of debt.
The document discusses how the net income approach suggests that a company's capital structure and leverage ratio can impact its value and overall cost of capital. Specifically, it states that if a company takes on more debt, which has a lower cost than equity, then its overall cost of capital will decrease, leading to an increase in the value of the firm and the market price of its shares. It lists some key assumptions, including that debt has a lower cost than equity and that investor risk perception is unchanged by debt levels. Finally, it includes a diagram showing the relationships between cost of equity, overall cost of capital, and cost of debt.
The document discusses how the net income approach suggests that a company's capital structure and leverage ratio can impact its value and overall cost of capital. Specifically, it states that if a company takes on more debt, which has a lower cost than equity, then its overall cost of capital will decrease, leading to an increase in the value of the firm and the market price of its shares. It lists some key assumptions, including that debt has a lower cost than equity and that investor risk perception is unchanged by debt levels. Finally, it includes a diagram showing the relationships between cost of equity, overall cost of capital, and cost of debt.
Net Income Approach suggested by The “Durand” the
capital structure decision is relevant to the valuation of the firm or we can say change Leverage ratio will lead to change in the value of the firm and overall cost of capital. If Rate is high( ) then Cost of capita is less( ), Value of the firm will increase( ) and also Market price of the share will increase( ) Assumptions
Cost of debt is lower than cost of equity.
Risk perception of investor is not changed by the use of debt No tax Diagram
Ke = Cost of Equity Ko = Cost of overall cost of capital Kd = Cost of debt