Decreased Valuation and Increased Overall Cost of Capital

Beyond a certain critical point, further increases in debt proportions are not considered desirable. They increase financial risks so much that both ki and ke start rising rapidly causing (k) to rise and (V) to fall. In the effect of an increase in B S ratio from 1.08 to 6.67  from 1·405 per cent and to decrease (V) from Rs 2,88,210 to Rs 2.75.000.

A numerical illustration given in its graphic presentation in further help to clarify the relationship between leverage and cost of capital. They present hypothetical changes similar to those envisaged by the traditional approach and examine the leverage of the individual variables. We have assumed, in addition to other at the beginning of the chapter, that given capital market conditions the company can repurchase its own shares. The face value of a share is Rs 40 and that of debentures Rs 100 each. The symbols used in the same meaning as explained at the beginning of the chapter.

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