NET OPERATING INCOME FR

APPROACH (NOI)
MEANING
• Net Operating Income means earnings before interest
and tax (EBIT). According to this approach, capital
structure decisions of the firm are irrelevant.
• Any change in the leverage will not lead to any change
in the total value of the firm and the market price of
shares, as the overall cost of capital is independent of
the degree of leverage. As a result, the division
between debt and equity is irrelevant.
ASSUMPTIONS
• The Weighted Average Cost of Capital (WACC) is
constant and irrelevant to the capital structure.
• The valuation of a firm is determined by its Net
Operating Income and WACC.
• Corporate Income Taxes do not exist.
• Value of equity is the difference between total firm
value less value of debt i.e. Value of Equity = Total
Value of the Firm – Value of Debt.

Value of firm = EBIT

Ko
CAPITAL STRUCTURE | FINANCIAL ACCOUNTING
1
 Diagrammatic representation of FR
NOI Approach to Capital Structure

• Kd and Ko remain constant as the degree

of leverage increases and both the curves
are parallel to X-axis.
• Cost of equity (Ke) is equal to Ko when
leverage is zero.

CAPITAL STRUCTURE | FINANCIAL ACCOUNTING 2