How good are the relationships that you have with your colleagues?
To explain the relationship among capital structure, cost of capital and value of the firm various theories have been propounded by different authors. There are four major theories which present differing views on the relationship between use of financial leverage and common stock value.
These theories differ in considering the relevance of capital structure decision to the valuation of the firm. We shall discuss these four theories in detail: The theory is based on the following assumptions: The firm is expected to continue indefinitely.
There is long-term debt and common stock in capital. The cost of debt is less than the equity capitalization rate, or the cost of equity. The financial risk perception of the investors remains unaltered with the change in financial leverage.
There is no corporate tax. According to him the decision relating to capital structure has an impact on the valuation of the firm. This means the company can influence its value by altering its financial leverage.
In other words, a company can increase its value and reduce the overall cost of capital by increasing the proportion of debt in its capital structure. On the contrary, the value of the firm will decrease and overall cost of capital will increase if the financial leverage of the firm What are the relationship among the.
The theory explains that cost of debt is cheaper than cost of equity and hence, the greater the financial leverage lower will be the overall cost of capital. If the cost of debt and cost of equity remains constant more use of debt in the capital structure will magnify the earnings per share and thereby the market value per share.
We know, the value of the firm is ascertained by the following formula: When the average cost of capital is minimum, the value of the firm will become maximum.
As the cost of capital declines, the market price of shares increases. The capital structure of a company is given below: The company earned a profit before interest and tax Rs 6, 50, Calculate the value of the firm under the NI approach and also calculate overall cost of capital of the firm.
Computation of value of the firm and overall cost of capital: Net Operating Income Approach: This theory has just the opposite approach of the net income theory. This theory is based on the following assumptions: Cost of debt Kd and Overall cost of capital Ko remain constant. Market capitalizes the value of the firm as a whole.
This approach, which is just the reverse of Net Income approach, shows that the capital structure decision is irrelevant in maximizing the value of the firm. According to this approach, change in the capital structure of a company does not affect the market value of the firm and the overall cost of capital remains constant irrespective of the method of financing.
In other words, change in financial leverage does not lead to any change in the value of the firm and both the market price of shares and overall cost of capital of the firm remain independent to the degree of financial leverage.
Since the theory assumes that the overall capitalization rate remains constant irrespective of the degree of financial leverage the value of firm, V is determined in the following way: From the above presentation we find that division of capitalization as equity and debt is irrelevant as the market evaluates the firm as a whole.
Under this approach, the value of equity 5 is found as a residual by subtracting the value of the debt D from the total value of the firm V i.
This will induce shareholders to get higher returns on their investment so that higher risks may be compensated. Debt financing has two parts: The real cost of debt is the sum of explicit and implicit costs. Explicit cost remains fixed as it represents interest and the firm is assumed to borrow at a given rate.
So increase in proportion of debt in the capital structure will not increase the cost of debt; but the cost of equity increases as the proportion of debt increases in the capital structure.
Since this cost increase is due to increase in debt it is known as implicit cost of debt. The advantage of using debt being a cheaper source is neutralized by the increased cost of equity. Hence this approach shows that real cost of equity and real cost of debt are same and are equal to overall cost of capital K.
Since the capital structure decision or leverage has no impact on the value of the firm it remains constant and there is no optimum capital structure.Chapter 2.
Midterm 1. STUDY. PLAY. The damage to an ecosystem caused by a hurricane or flood can be referred to as. a disturbance. The relationship among atoms, elements, and compounds is most like the relationship among which of the following groupings.
grains of .
Used to show a relationship, choice, division, etc. when three or more people or things are involved: he divided his fortune among his four children. A myth in need of debunking The reason why among versus between falls into the ‘grammar myth’ category is this.
College Students & Relationships. Maintaining Healthy Relationships. Communication--both people in the relationship need to feel free to express positive and negative feelings, complaints, and affection Active Listening Skills Handout: check out misunderstandings;.
Companies often promote a particular set of values through a corporate mission statement, code of ethics or slogan. The extent to which individual employees apply these values on a day-to-day. May 02, · There is a persistent but unfounded notion that between can be used only of two items and that among must be used for more than two.
Between has been used of more than two since Old English; it is especially appropriate to denote a one-to-one . What part of the paper helps you organize your ideas and shows the relationships among ideas in your writing?