CS Executive · Corporate Accounting and Financial Management · Capital Structure
Under the Net Operating Income (NOI) approach, which statement is correct?
Under the NOI approach the overall cost of capital and firm value stay constant at every debt level. The benefit of cheaper debt is exactly offset by a rising cost of equity as financial risk grows, so capital structure is irrelevant to value.
- ACost of equity falls as debt increases, leaving Ko lower
- BMarket value of the firm is independent of its capital structure because cost of equity rises to offset cheaper debtCorrect
- CCost of debt rises steadily with leverage while cost of equity is constant
- DThere is an optimal capital structure at a moderate debt level
Explanation
NOI assumes Ko is constant at all leverage levels. Cheaper debt is exactly offset by a higher cost of equity because shareholders demand compensation for greater financial risk. So value does not change with capital structure, and no optimal structure exists. Option 0 reverses the equity cost movement.
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