The Net Income approach introduced by David Durand states that a company's capital structure and financial leverage is relevant to the valuation of the firm. According to this approach, increasing financial leverage will decrease the weighted average cost of capital and increase firm value and equity share price. Conversely, decreasing financial leverage will increase the weighted average cost of capital and decrease firm value and equity share price. The key assumptions of this approach are that there are no taxes, the cost of debt is less than the cost of equity, and using debt does not change investor risk perception. The document provides an example calculation to determine a firm's total value, overall cost of capital before and after issuing new debentures to redeem equity shares.

1. NET INCOME (NI) APPROACH

2.  Net Income theory was introduced by David
Durand. According to this approach, the
capital structure decision is relevant to the
valuation of the firm. This means that a
change in the financial leverage will
automatically lead to a corresponding change
in the overall cost of capital as well as the
total value of the firm.

3.  According to NI approach, if the financial
leverage increases, the weighted average
cost of capital decreases and the value of the
firm and the market price of the equity shares
increases. Similarly, if the financial leverage
decreases, the weighted average cost of
capital increases and the value of the firm and
the market price of the equity shares
decreases.

4. Assumptions of NI approach
 There are no taxes
 The cost of debt is less than the cost of
equity.
 The use of debt does not change the risk
perception of the investors

5.  A ltd is expecting an annual Ebit of
Rs.1000000.the company has Rs.4000000 in
10%debenture. The equity capitalisation rate is
12.5%. The company decides to raise Rs.1000000
by issue of 10% debenture and use proceeds
there of two buy back and cancel the equity
shares.
 You are required to calculate
 The total value of the firm
 The overall cost of capital before and after the
issue of fresh debenture for redeeming equity
shares