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V = (S+B)
NIA
Cost
ke, ko
ke
kd
ko
kd
Debt
Example
Example
Net Operating Income (EBIT)
(Less) Interest on
PBT ( no tax so) PAT (NI)
Ke
Value of equity (S) [ NI/Ke)
Value of debt (B)
Value of the firm [S+B]
Overall cost of capital Ko = EBIT/V
Rs.
50000
20000
30000
0.125
240000
200000
440000
11.36%
50000
30000
20000
0.125
160000
300000
460000
10.9%
According
to
NOI
approach the value of
the firm and the
weighted average cost
of
capital
are
independent of the
firms
capital
structure., Therefore
value of the company
is the same.
Cost
ke
ko
kd
Debt
Example
Example
Rs.
MM approach
Traditional Approach
Contd
Example:
Particulars
Amount
Rs.
EBIT
Less : Interest (10% on Debt)
EAT [NI]
Equity Capitalisation rate
Total MV of Equity (S) [NI/Ke]
Total MV of Debt (B)
Total Value of the Firm [V=S+B]
Ko [EBIT/V]
Therefore the Ko is approx
40000
10000
30000
0.16
187500
100000
287500
0.139
14%
EBIT
40000
Less : Interest
16500
NI
23500
Ke
0.17
S = NI / Ke
138235
B=
150000
Then V = (S+B)
288235
Ko = [ EBIT / V ]
0.138
Therefore the Ko is approx
14%
Thus we can understand that there is no relevant of
the Ko with the proportion of S: B
At the same time suppose if the firm issue additional debt Rs.100000
i.e. Rs.200000 then int is 12.5% and Ke 20 % then Ko will differ from the
past CS
Rs.
EBIT
Less : interest
NI
Ke
Value of the Equity (S) [NI / Ke]
Value of the Debt (D)
Value of the firm V = [S+D]
Ko = EBIT / V
40000
25000
15000
0.20
75000
200000
275000
0.145
Capital mix
Maturity & priority
Terms & conditions
Currency
Flexibility
Risk
Income
Control
Timing
Assets
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Debt and Non debt tax shields
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Early repayment
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Marketability and timing
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