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assumptions: (1) The cost of debt is less than cost of equity. (ii) The debt content does not change the risk perception of the investors. NI Thus, the Net Income Approach suggests that an increase in financial leverage will lead to decline in the weighted average cost of capital and the value of the firm as well as market price of equity shares will increase. On the other hand, a decrease in the financial leverage will cause on increase in the weighted average cost of capital and a consequent decline in the value as well as market price of equity shares The value of the firm on the basis of Net Income Approach can be ascertained as follows: V=S+D where, V = Value of the firm S = Market value of equity D = Market value of Debt The market value of Equity can be ascertained as follows: 17 SEK where, S = Market value of Equity NI = Earnings available to Equity shareholders. Ke = Equity capitalisation rate Under Net Income approach, the value of the firm will be maximum at a point where weighted average cost of capital is minimum. Therefore, the theory suggests maximum possible debt- financing for minimizing the cost of capital. The overall cost capital is determined as follows: Overall cost of capital - Value of the firm EBIT Illustration 6: The EBIT of Kripa Ltd is Rs. 5,00,000. The company has 10% Debentures of Rs. 20,00,000. The equity capitalisation rate is 15%. You are required to calculate: (i) Market value of Equity (ii) Value of the Company (iii) Overall cost of capital