Increased Valuation and Decreased Overall Cost of Capital

During the first phase, increasing leverage increases the total valuation of the firm and low overall cost of capital. As the proportion of debt in the capital structure increases the equity (k) begins to rise as a reflection of the increased financial risk. But it is not me enough to off set the advantage of using the cheaper source of capital. Likewise, for the range of this phase, the cost of debt (k) either remains constant or rises to a very small because the proportion of debt by the lender is considered to be within safe limits. Therefore, are prepared to lend to the firm at almost the same rate of interest. Since debt is type cheaper source of capital than equity, the combined effect is that the overall cost of capital to from with the increasing use of debt. An increase in levera from 0.53 to 1.08 has had the effect of increasing the total market value from Rs 2,87,580  Rs 2,88.235 and decreasing the overall capitalization rate from 13.9 to 13.8 per cent.

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