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  • Net Operating Income Approach

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    urmila rana
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    This document discusses how increasing a company's debt proportion while keeping other factors the same affects its valuation. It analyzes two scenarios: 1) EBIT of $100,000 with debt of $300,000 and $400,000. The total market value stays $800,000 but equity cost rises from 14% to 15%. 2) EBIT of $200,000 with debt of $500,000 and $700,000. Again, the total market value of $1,273,885 remains unchanged, but equity cost increases from 18% to 20%. The key point is that under the net operating income approach, increasing debt proportion leaves the total market value unchanged but raises the cost

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    INCOME APPROACH IMT

    Original Title

    Net+Operating+Income+Approach

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    This document discusses how increasing a company's debt proportion while keeping other factors the same affects its valuation. It analyzes two scenarios: 1) EBIT of $100,000 with debt of $300,000 and $400,000. The total market value stays $800,000 but equity cost rises from 14% to 15%. 2) EBIT of $200,000 with debt of $500,000 and $700,000. Again, the total market value of $1,273,885 remains unchanged, but equity cost increases from 18% to 20%. The key point is that under the net operating income approach, increasing debt proportion leaves the total market value unchanged but raises the cost

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    6 views4 pages

    Net Operating Income Approach

    Uploaded by

    urmila rana
    This document discusses how increasing a company's debt proportion while keeping other factors the same affects its valuation. It analyzes two scenarios: 1) EBIT of $100,000 with debt of $300,000 and $400,000. The total market value stays $800,000 but equity cost rises from 14% to 15%. 2) EBIT of $200,000 with debt of $500,000 and $700,000. Again, the total market value of $1,273,885 remains unchanged, but equity cost increases from 18% to 20%. The key point is that under the net operating income approach, increasing debt proportion leaves the total market value unchanged but raises the cost

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 4

    Consider a fictitious company with below figures.

    All figures in INR

    Earninings before interest tax (EBIT) 100,000


    Debt 300,000
    Cost of debt 10%
    WACC 12.5%

    Calculating the value of the company

    EBIT 100,000
    WACC 12.5%

    Market value of company (EBIT/WACC) 800,000

    Debt 300,000
    Total equity (Total market value - Total equity) 500,000

    Shareholders earnings (EBIT - Interest on debt) 70,000

    Cost of equity 14%

    Now, assume that the proportion of debt increases from 300,000 to 400,000 and everything else remains same

    EBIT 100,000
    WACC 12.5%

    Market Value of company (EBIT/WACC) 800,000

    Debt 400,000
    Total equity (Total market value - Total equity) 400,000
    Shareholders earnings (EBIT - Interest on debt) 60,000

    Cost of equity 15%

    As observed, in the case of Net Operating Income approach, with the increase in debt
    proportion, the total market value of the company remains unchanged, but the cost of equity
    increases.
    Consider a fictitious company with below figures. All figures in INR

    Earninings before interest tax (EBIT) 200,000


    Debt 500,000
    Cost of debt 12%
    WACC 15.7%

    Calculating the value of the company

    EBIT 200,000
    WACC 15.7%

    Market Value of company (EBIT/WACC) 1,273,885

    Debt 500,000
    Total equity (Total market value - Total equity) 773,885

    Shareholders earnings (EBIT - Interest on debt) 140,000

    Cost of equity 18%

    Now, assume that the proportion of debt increases from 500,000 to 700,000 and everything else remains same

    EBIT 200,000
    WACC 15.7%

    Market value of company (EBIT/WACC) 1,273,885

    Debt 700,000
    Total equity (Total market value - Total equity) 573,885
    Shareholders earnings (EBIT - Interest on debt) 116,000

    Cost of equity 20%

    As observed, in the case of Net Operating Income approach, with the increase in debt proportion,
    the total market value of the company remains unchanged, but the cost of equity increases.

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