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Increase in Value

In order to examine the effect of a change in financing-mix on the firm’s overall (weighted average) cost of capital and its total value, let us suppose that the firm has decided to raise amount of debenture by Rs 1,00,000 and use the proceeds to retire the equity shares. The k1 and k2 would remain unaffected as per the assumptions of the NI Approach. In the new situation, the value of the firm is shown in Table.

TABLE

Increase in Value

Increase in Value

Thus, the use of additional debt has caused the total value of the firm to increase and the overall cost of capital to decrease.

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