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    According To Gerestenbeg, "Capital Structure of

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    Anmol Gupta
    The document discusses capital structure theories including: 1. The Net Income Approach developed by Durand, which states that capital structure decisions are relevant to valuation and increased debt increases shareholder earnings. 2. The Net Operating Income Approach, also developed by Durand, which argues the opposite - that capital structure decisions are irrelevant to valuation and increased debt increases shareholder risk. 3. Other theories discussed include the Traditional Approach and Modigliani and Miller Approach. The document provides formulas for calculating firm value, equity value, and weighted average cost of capital under the Net Income and Net Operating Income approaches.

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    According To Gerestenbeg, "Capital Structure of

    Uploaded by

    Anmol Gupta
    29 views11 pages
    The document discusses capital structure theories including: 1. The Net Income Approach developed by Durand, which states that capital structure decisions are relevant to valuation and increased debt increases shareholder earnings. 2. The Net Operating Income Approach, also developed by Durand, which argues the opposite - that capital structure decisions are irrelevant to valuation and increased debt increases shareholder risk. 3. Other theories discussed include the Traditional Approach and Modigliani and Miller Approach. The document provides formulas for calculating firm value, equity value, and weighted average cost of capital under the Net Income and Net Operating Income approaches.

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    The document discusses capital structure theories including: 1. The Net Income Approach developed by Durand, which states that capital structure decisions are relevant to valuation and increased debt increases shareholder earnings. 2. The Net Operating Income Approach, also developed by Durand, which argues the opposite - that capital structure decisions are irrelevant to valuation and increased debt increases shareholder risk. 3. Other theories discussed include the Traditional Approach and Modigliani and Miller Approach. The document provides formulas for calculating firm value, equity value, and weighted average cost of capital under the Net Income and Net Operating Income approaches.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    29 views11 pages

    According To Gerestenbeg, "Capital Structure of

    Uploaded by

    Anmol Gupta
    The document discusses capital structure theories including: 1. The Net Income Approach developed by Durand, which states that capital structure decisions are relevant to valuation and increased debt increases shareholder earnings. 2. The Net Operating Income Approach, also developed by Durand, which argues the opposite - that capital structure decisions are irrelevant to valuation and increased debt increases shareholder risk. 3. Other theories discussed include the Traditional Approach and Modigliani and Miller Approach. The document provides formulas for calculating firm value, equity value, and weighted average cost of capital under the Net Income and Net Operating Income approaches.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 11

    CAPITAL STRUCTURE

    According to Gerestenbeg, “Capital structure of


    a company refers to the composition or make-up
    of its capitalisation and it includes all long-term
    capital resources viz : loans, reserves, shares and
    books.”
    THEORIES OF CAPITAL
    STRUCTURE
    • The main contributors to the theories are Durand, Ezra, Solomon,
    Modigliani and Miller.
    • The important theories are:
    1. Net Income Approach.
    2. Net Operating Income Approach.
    3. The Traditional Approach.
    4. Modigliani and Miller Approach.
    1. Net Income Approach:
    This approach has been developed by Durand. The main findings
    are:
     Capital structure decisions are relevant to the valuation of the
    firm.
     Increased use of debt will increase the shareholders’ earning.
    ASSUMPTIONS
    • Capital structure consists of debt and equity.
    • Cost of debt is less than cost of equity (i.e. Kd<Ke).
    • The use of debt content does not change the risk perception of
    investors.
    CALCULATION OF THE VALUE OF THE FIRM

    • According to Net Income Approach the value of the firm can be


    ascertained as follows:
    • V = S+ D
    where,
    V= Value of the firm
    S= Market value of equity=Earnings available for equity shareholders/
    Equity capitalisation rate.
    D= Market value of debt.
    CALCULATION OF OVERALL COST
    OF CAPITAL
    • According to Net Income Approach the overall cost of capital or
    expected rate of return (WACC) can be calculated as follows:
    • (Ko) = EBIT X 100
    v
    where,
    Ko= Overall cost of capital
    EBIT= Earnings before interest and tax
    V= Value of firm
    2. NET OPERATING INCOME
    (NOI) APPROACH
    Another theory of capital structure, suggested but Durand, is the Net
    Operating Income approach. This approach is simply opposite to the
    Net Income approach.
    • The main findings are:
    Capital structure decisions are irrelevant to the valuation of the
    firm:.
    Increased use of debt will increase the financial risk of the
    shareholders.
    ASSUMPTIONS

    (a) The market capitalises the value of firm as a whole.


    (b) Cost of debt (Kd) is constant.
    (c) Increases use of debt increases the financial risk of equity shareholder
    which, in turn, raises the cost of equity (Ke).
    (d) Overall cost of capital (Ko) remains constant for all levels of debt equ
    mix.
    (e) There is no corporate income tax.
    VARIOUS CALCULATION UNDER NET OPERATING INCOME
    APPROACH ARE EXPLAINED BELOW:

    1. Value of Firm (V): 2. Market Value of Equity (S):


    V = EBIT S =V–D
    Ko where, S= Market value of equity
    where,
    V= Value of firm
    V = Value of firm
    D = Market value of debt.
    Ko= Overall Cost of Capital
    EBIT= Earnings Before Interest & taxes
    NET OPERATING INCOME
    V/S NET INCOME
    APPROACH
    Net operating income Approach Net income Approach
    • No relevance in capital structure. • Relevance in capital structure.
    • Degree of leverage is irrelevant to cost of • Change in degree of leverage will
    capital (assumes). change WACC (assumes).
    • It has constant cost of capital. • No taxes.
    • Equity value is residual (derived by • Cost of debt is less than cost of equity.
    subtracting value of debt from value of firm). • Change in debt will not change
    • Changes perception of investor with increase perception of investors.
    in debt.
    THANK YOU !!!

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