Capital Structure And The Performance Of Firm Free Essay Example, 4500 words

2.3.1 Theory of Net Income (NI)The theory of net income states that there prevails a connection between firm s value and capital structure. A company s capital structure influences its WACC and therefore directly has an impact on the firm s value. The assumptions of net income approach are: It believes that an incessant augmentation in debt generally does not impact the investors risk perception. Cost/price of equity is more than the debt s cost. The tax on the corporate income does not exist. As per this approach, more utilisation of the debt capital causes lessening of WACC. This results in the increased value of the company. When the WACC is decreased and EBIT remains constant, then the worth of company always increase. Therefore, this approach states that a company will have utmost value when WACC will be at its minimum i. e. at the time when the company is nearly debt-financed. If the theory is valid, then the average is considered as an important variable and the financing decisions will also have the considerable effect on firm s valuation (Booth et al, 2001). 2.3.2 Theory of Net Operating Income (NOI)This approach is just reverse of the NI approach. We will write a custom essay sample on Capital Structure And The Performance Of Firm or any topic specifically for you Only $17.96 $11.86/page Assumptions of this theory are: WACC always remains stable and it relies on business risk. The value of the company is estimated using WACC only. Cost/price of debt also remains stable. The tax on the corporate income does not exist.