Is question no 2 in our syllabus ?? ..if yes then how it is solved …what is the differencee
Rishika JIntermediate
Ca inter fm
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Yes, it’s in our syllabus – Ne operating income approach is same as MM Model. So do second part as per MM.
Net income approach is the one in which it is assumed that as we raise more debt, cost of equity will remain the same. [Normally, it rises]. Hence, Kc will fall as we acquire more debt. This model is very illogical.
Yes, it is there in the Capital Structure chapter.
NI Approach falls under relevance theory while NOI Approach is a classification of irrelevance theory.
in the case of NI Approach, if debt or borrowed funds taken by a firm increases, it affects the value of the firm- the WACC decreases, and the value of the firm increases. Hence a category of relevance theory. In this approach, the Ke and Kd is assumed to be constant
A B
EBIT 3.6L 3.6L
-I – 0.72L
(12% OF 6L)
PBT/PAT 3.6L 2.88L
(no tax)
*1/Ke i.e. 18%
(we get the value
of equity) 20L 16L
+ value of
debt – 6L
VALUE OF FIRM = 20L 22L
the overall cost of capital of the firm is WACC so for firm A it will be Ke only i.e. 18% and for
firm B we have WeKe+WdKd i.e. 0.18*16L+0.12*6L/22L*100= 16.36%