What is financial leverage and how does it affect the cost of capital and the value of a firm according to the NTI approach?
Understand the Problem
The question appears to discuss the concept of financial leverage, its implications on the cost of capital, and the effect of different capital structures on a firm's value, particularly referencing the NTI approach.
Answer
In the NTI approach, increased leverage lowers the cost of capital and raises the firm's value.
According to the Net Income Approach (NTI), financial leverage affects a firm's cost of capital and value by increasing the proportion of debt, leading to a lower overall cost of capital. More leverage results in a higher firm value and market price of shares, assuming no change in risk or taxes.
Answer for screen readers
According to the Net Income Approach (NTI), financial leverage affects a firm's cost of capital and value by increasing the proportion of debt, leading to a lower overall cost of capital. More leverage results in a higher firm value and market price of shares, assuming no change in risk or taxes.
More Information
The NTI approach assumes no taxes and unchanged risk, highlighting the benefits of debt financing due to lower costs compared to equity.
Tips
A common mistake is ignoring the assumptions of no taxes and constant risk when applying the NTI approach.
Sources
- What is Financial Leverage? - Vintti - vintti.com
- What Is Financial Leverage, and Why Is It Important? - Investopedia - investopedia.com
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