3. By David Durand
According to this theory a firm can increase the
value of firm and reduce the over all cost of capital
by increasing the proportion of debt in its capital
structure to the max. possible extent.
4. First there are no taxes.
Second the cost of debt is less than the cost of
equity.
Third the cost of debt capital and cost of equity
capital remain constant.
5. A company’s expected annual EBIT is Rs. 50000. The
company has Rs 2,00,000, 10% debenture. The cost of
equity of the company is 12.5%.
6. Net Operating Income (EBIT) Rs 50,000
Less: Interest on debentures (I) 20,000
---------------------------
Earnings available to equity holders (EBT) 30,000
Equity Capitalization Rate (ke) 0.125
Market Value of Equity (S) = EBT/Ke ----------------------------
2,40,000
Market Value of Debt (D) 2,00,000
Total Value of the firm (S+D) = V ------------------------------
4,40,000
Overall cost of capital = Ko = EBIT/V (%) 11.36
7. By David Durand
Net Operating Income (NOI) approach is the exact
opposite of the Net Income (NI) approach.
According to this theory , the total market value of
the firm (V) is not affected by change in the capital
structure and the overall cost of capital(Ko) remain
fixed irrespective of the debt equity mix.
8. Overall cost of capital is constant.
The income tax does not exist.
The business risk at each level of debt-equity
mix remain constant.
9. A company’s expected annual EBIT is Rs. 50000. The
company has Rs 2,00,000, 10% debenture. The cost of
equity of the company is 12.5%.
Ko = (EBIT – I)/(V – D) or EBT/S
= Earning available to equity holders/Total
market value of equity shares
10. Net Operating Income (EBIT) Rs. 50,000
capitalisation rate (Ke) 0.125
-----------------------------
Total market value of the firm (V) = EBIT/Ke Rs 4,00,000
Total Value of Debt Rs 2,00,000
Total Market Value of Debt (S) = (V – D) Rs 2,00,000
Ko= 50,000 - 30,000 / 2,00,000 = 0.1 or 10%
11. By Ezra Soloman
According to this theory a firm can reduce the
overall cost of capital(Ko) or increase the total
value of firm(V) of the firm by increasing the
debt proportion in its capital structure to a
certain limit .
12. EBIT = Rs. 150,000, presently 100% equity finance with Ke = 16%. Introduction of debt to
the extent of Rs. 300,000 @ 10% interest rate or Rs. 500,000 @ 12%.
For case I, Ke = 17% and for case II, Ke = 20%. Find the value of firm and the WACC
m.
13. Particulars Presently case I case II
Debt component - 300,000 500,000
Rate of interest 0% 10% 12%
EBIT 150,000 150,000 150,000
(-) Interest - 30,000 60,000
EBT 150,000 120,000 90,000
Cost of equity (Ke) 16% 17% 20%
Value of Equity(S= EBT / Ke) 937,500 705,882 450,000
Total Value of Firm ( S + D) 937,500 1,005,882 950,000
Ko =EBIT / V * 100 16.00% 14.91% 15.79%
14. THANK YOU
PRESENTED TO: PRESENTED BY:
Mr. VIKAS Ranjini Verma
JAIN Sonu Sanklecha
(SIR) Preety Kashyap
Rajani Kumari
Nidhi Vats
