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Net Operating Income Approach (Noi) : Meaning Assumptions

The Net Operating Income (NOI) approach assumes that a firm's capital structure decisions do not impact its total value. It assumes the weighted average cost of capital (WACC) is constant regardless of capital structure. The value of the firm is determined solely by its net operating income and WACC. Changes in leverage will not change the total firm value or share price as the overall cost of capital is independent of leverage. The division of debt and equity is considered irrelevant under this approach.

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404 views2 pages

Net Operating Income Approach (Noi) : Meaning Assumptions

The Net Operating Income (NOI) approach assumes that a firm's capital structure decisions do not impact its total value. It assumes the weighted average cost of capital (WACC) is constant regardless of capital structure. The value of the firm is determined solely by its net operating income and WACC. Changes in leverage will not change the total firm value or share price as the overall cost of capital is independent of leverage. The division of debt and equity is considered irrelevant under this approach.

Uploaded by

Rahul punjabi
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  • Net Operating Income Approach (NOI): Explains the Net Operating Income approach including its implications and underlying assumptions in capital structure decisions.

NET OPERATING INCOME FR

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

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

FR MEANING • Net Operating Income means earnings before interest and tax (EBIT). According to this approach, capital struct
FR • Kd and Ko remain constant as the degree of leverage increases and both the curves are parallel to X-axis. • Cost of eq

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