Value of the Firm (NOI Approach)

Let us further suppose that the firm retires debt by Rs 1,00,000 by issuing fresh equity shares of the same amount. The value of the firm would remain unchanged at Rs 4,00,000 and the equity capitalization rate would come down to 13.33 per cent as manifested in the calculations in Table.

Total Value of the Firm (NOI Approach)

Optimum Capital Structure

Optimum Capital Structure

The significant feature is that the equity-capitalization rate, ke increases with the increase in the degree of leverage. It has gone up from 15 per cent to 20 per cent with the increase in leverage from 0.50 to 0.75. The equity capitalization rate decreases with the decrease in the degree of leverage. It has come down from 15 per cent to 13.33 per cent with the decrease in leverage from 0.50 to 0.25.

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