NI Approach

A companys expected annual net operating

income(EBIT) is Rs.50,000. The company has
Rs.2,00,000, 10% debentures. The equity
capitalization rate(ke) of the company is
12.5%.What is the Market value of the firm?
What is the overall cost of capital?
 Market value of firm = Rs. 4,40,000
Overall Capitalization Rate = 11.36%
 Now let us see what is the effect on firm value
and cost of capital if the firm increases the
value of debenture by Rs.100,000 and reduces
the equivalent amount of equity
 Market Value of Firm = Rs. 4,60,000
Overall Capitalization Rate = 10.86%
 Now let us see what is the effect on firm value
and cost of capital if the firm decreases the
value of debenture by Rs.100,000 and reduces
the equivalent amount of equity
 Market Value of Firm = Rs.4,20,000

Overall capitalization rate = 11.90%

 NOI Approach
Operating income Rs.50,000; cost of debt 10%
and outstanding debt Rs.200,000. If the
overall capitalization rate(overall cost of
capital) is 12.5%, what would be the total
value of the firm and equity capitalization
rate?
 Overall firm value = 4,00,000

Equity capitalization rate = 15%

 If amount of debt increases by Rs.100,000 and
corresponding decease in equity by same
amount. what would be the total value of the
firm and equity capitalization rate?
 Overall firm value = 4,00,000

Equity capitalization rate = 20%

 If amount of debt decreases by Rs.100,000
and corresponding increase in equity by same
amount. what would be the total value of the
firm and equity capitalization rate?
 Overall firm value = 4,00,000

Equity capitalization rate = 13.33%