- Net Operating Income Approach:
- S = V – B = (EBIT/ Ke) – B
Where,
S = Value of equity
V = Value of firm
B = Value of debt
Ke= Equity Capitalization Rate
- Ke = EBIT – I / V-B x 100
- K = Kd [B/ V] = KE [S/ V]
Where,
Kd = Cost of Equity Capital
S = Market value of equity
- Net Income Approach
V = S + B
Where,
V = Value of firm
S = Value of equity
B = Value of debt
Market value of Equity, S can be written as:
S = NI/ Ke
Where,
S = Value of equity
NI = Earnings available for equity shareholders
Ke = Equity Capitalization Rate
K = Overall cost of capital
It is also written as:
K = EBIT/ V x 100
NI (Net Income):
Earnings before Interest and Tax xx
Less : Interest xx
PBT xx
Less : Tax xx
PAT xx
Less ; Pre-dividend (if any)
Amount available for equity shareholders xx
- Traditional Approach:
Traditional Approach contains some of the features of Net Income Approach and Net Operation Income Approach.
- Modigliani and Miller Approach:
- Value of Levered Firm:
Its formulae can be given by,
Vi = Vu + Bt
Where,
Vi = Value of levered firm
Vu = Value of unlevered firm
B = Amount of debt
t = Tax Rate
- Value of Unlevered Firm:
Vu = (I – t) EBT/ Ke
or,
Vu = Profits available for equity shareholders/ Equity Capitalization Rate
Note: The term unlevered means debt content in Capital Structure whereas the term levered means no debt content in Capital Structure.
Links of Previous Main Topic:-
- Budget and budgetary control
- Limitations of historical accounting
- Introduction to responsibility accounting
- Introduction to financial management
- Introduction and types of dividend
- Concept of cost of capital
- Capitalization meaning
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