Net Income Approach NI Homework Help

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Corporate finance for a business is based on mainly two means that is the debts and the equity whose proportions tend to vary from business to business according to the types of businesses. Capital structure or the capital mix generally is defined as the mix of debt and equity. A company or a firm can have a structure which includes fifty per cent of debts and equity each or in different percentages as well. The net income approach for capital theory states that the value of the firm or company is increased by reducing the overall cost of capital with the help of higher debt proportion. Since debt is considered as a cheaper source of finance as compared to the equity finance because the interest which are applied on debts are tax deductible therefore debts are an easy and handy option for financing the firm. Net income approach was first proposed by Durand and it measures the cost of capital in the form of weighted average cost of capital. Weighted average cost of capital is defined as the weighted average cost of debts and equities i.e. the amount of the capital which is raised by each source.For further knowledge about net income approach of capital structure kindly refer Net Income Approach NI Homework Help.
 

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Assumptions for Net Income Approach

 
Net income approach method of explaining capital structure has been formulated with certain assumptions which have been explained in the following section of Net Income Approach NI Homework Help
 
• First and for most assumption which is taken is that cost of debts is always less than the cost of equities.
• Secondly, the assumption was that there are no taxes levied.
• And lastly the increase in debt is not supposed to affect the confidence levels of the investors.
 
As stated earlier in Net Income Approach NI Homework Help,the use of debts proportionately for financing the company increases the value of the company and which can be varied by increasing or decreasing the ratio of debts and equity that is by altering the financial mix. The reasons for which cost of debt is cheaper are
 
• Lower rate of return: Since lenders require lower rates of return as compared to the ordinary shareholders which is provided by debts since they pose lower risks because they have prior claims on the liquidation and the annual income along with additional security therefore debts are preferred. Various other reasons can be studied in Net Income Approach NI Homework Help.
• Profitably business: less capital is paid for debt than equity since interest on debts can be used for pre-tax profits even before the calculation of the company taxes hence it reduces the tax liabilities on the company.
 

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