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Banking & Finance Articles
Page 87 of 102
Describe about net income approach in capital structure.
Capital structure plays an important role in value of a company. Different companies have different capital structures like some have capital based on debt, some have based on equity and some have a mixed or combination of both in their financial mix.Durand proposed net income approach and he states that change in cost of capital and valuation of company will change, if there a change in financial leverage. Capital structure is relevant to valuation of a firm. Increase in financial leverage leads to increase in weighted average cost of capital (WACC) and value of firm will increase.Market value of equity ...
Read MoreWrite the difference between Net operating income and net income.
The major differences between net operating income and net income are as follows −Net operating incomeNo relevance in capital structure.Degree of leverage is irrelevant to cost of capital (assumes).It has constant cost of capital.Equity value is residual.Changes perception of investor with increase in debt.Net incomeRelevance in capital structure.Change in degree of leverage will change WACC (assumes).No taxes.Cost of debt is less than cost of equity.Change in debt will not change perception of investors.
Read MoreHow to calculate cost of equity and market value of a firm?
SolutionThe solution is as follows −Debt ratioEquityDebtCost of debtWACCInterest Expenses (I)Market value of a company (V)Market value of Equity (E)Net operating income (EBIT – I)Cost of equity (Ke)0.003500000010%11.5%03625000362500362500010%0.20280000070000010%11.5%70000362500029250035550008.07%0.451925000157500010%11.5%157500362500020500034675005.65%0.702450000245000010%11.5%245000362500011750033800003.24%1.000350000010%11.5%35000036250001250032750000.35%Equity = book value * (1-debt ratio)Debt = book value * debt ratioInterest (I) = debt * cost of borrowedMarket value of a company (V) = EBIT/WACCMarket value of equity (E) = V – ICost of equity = E/V
Read MoreExplain Net operating income theory of capital structure.
Capital structure of a company depends on mix or ratio of debt and equity in their mode of their financing. Depending on what company prefer, some may have more debt or more equity in financing their asset, but final goal is to maximize their market value and their profits.Net operating income (NOI) was developed by David Durand. According to net operating income approach, firm value is not affected by change in company or firm’s debt components.Net operating income approach says that value of a firm depends on operating income and associated business risk. Value of firm will not be affected ...
Read MoreCalculate market equity using below data according to the M-M Approach.
Company XCompany YRsRsNet operating income2000020000Cost of debt02500Net income2000017500Cost of equity0.080.10Market value of shares250000175000Market value of debt050000Total value of firm250000225000Cost of capital (Avg)0.950.08Debt equity ratio00.8Assumptions: 1) no corporate tax 2) equilibrium value is 12%.SolutionThe solution is explained below −Company XCompany YRsRsNet operating income2000020000(-)Cost of debt02500Net income2000017500Equilibrium cost of equity (12.5%)0.1250.125Value of firm160000140000Market value of debt050000Market value if equity16000090000
Read MoreHow to calculate market value of a company?
SolutionThe solution is given below −Company X is unlevered, which means, interest on debt is 0.Company y is levered, which means, interest on debt is 7000 (175000*4%)Market valueCompany XCompany YRsRsNet operating income4500045000Interest on debt070004500038000Profit before taxes4500038000Taxes (40%)18000152002700022800Capitalization rate (12%)0.120.12Market value equity225000190000Market value of debt0175000Total value225000365000
Read MoreHow cost of equity in different countries are calculated?
SolutionThe solution is as follows −Country 1: No taxesa) Debt to equity ratio is ZeroCost of equity = WACC + (WACC – Cost of debt) * (debt/equity)Cost of equity = 15% + (15% - 5%) * 0 => 10%b) Debt to equity ratio is 1Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)Cost of equity = 15% + (15% – 5%) * 1Cost of equity = 10% + 5% => 20%c) Debt to equity ratio is 2 Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)Cost of equity = 15% + (15% – ...
Read MoreHow to prepare bank reconciliation statement?
SolutionThe solution is as follows −Cash bookBank statementDividend (Rs.2200/-)Balance (Rs.25000/-)Interest error(Rs.800/-)Uncashed check (Rs.2000/*)Deposited(Rs.3800/-)Uncredited (Rs.3500/-)Cash short(Rs.1200/*)Dues paid(Rs.1000/-)ABC Ltd BankReconciliation statementas on 30th September, XXXXBank overdraft (Dr)25000(+)Check issued (not enchased)2000Dividends on shares (collected by bank)2200Interest charged (recorded twice)800Check deposited (not entered in cash book)3800880033800(-)Cash short (credit side of bank column)1200Dues paid by bank1000Uncredited check (outstation)3500(5700)Balance (as per cash book) (Cr)28100
Read MoreUsing the below trail balance, prepare income statement for the start-up company ABC as on 31st April XXXX
Trail balance of ABC Company as on 31st April XXXXDebit ($)Credit ($)Banking equipment10000DebtorsBank5000Capital16000Drawings600Loan1800CreditorsServices18000Salaries9500Telephone expenses7002580025800SolutionThe solution is as follows −While preparing income statement, we consider only expenses and income.Income => services => 18000Expenses => salaries + telephone expenses => 9500 + 700 => 10200Income statement for the company ABC for period ending on 31st April XXXXDebit ($)Credit ($)Income18000(services)18000Expenses(10200)Salaries95007800Telephone expenses700Net profit
Read MoreCompany X has estimated their demand levels of their product A
Sales volumes of A (units)1500016500182001900020000Probability0.150.180.190.210.22Selling price per unit is Rs. 8/- with marginal cost = Rs. 4.80/- and fixed cost = Rs. 42000/-Calculate probability of company’sa) Break evenb) Makes profit of minimum Rs.20000/-SolutionThe solution is explained below −a) Break evenCalculated contribution costContribution cost= sales cost – marginal costContribution cost= 8 – 4.80Contribution cost= 3.20/-Breakeven point = fixed cost / contribution cost= 42000/3.20= 13125 units (app)Probability of sales more than or equal to 8077 unitsProbability of sales = (0.15+0.18+0.22+0.24+0.26) => 0.95 => 95%b) Makes profit of minimum Rs.20000/-Total contribution = (fixed cost) + profit => 42000 + 20000 => 62000 - ...
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