Bissoy.com
Doctors Medicines MCQs Q&A

Assertion A): According to Net Income (NI) approach, capital structure decision is relevant in the valuation of firm. Reason R): A firm can change its total value and its overall cost of capital by change in the degree of leverage in its capital structure. In the context of the above two statements, which one of the following options is correct?

Assertion A): According to Net Income (NI) approach, capital structure decision is relevant in the valuation of firm. Reason R): A firm can change its total value and its overall cost of capital by change in the degree of leverage in its capital structure. In the context of the above two statements, which one of the following options is correct? Correct Answer Both A) and R) are correct and R) is the right explanation of A)

Net Income (NI) Theory:

According to this approach, capital structure decision is relevant to the valuation of the firm in as much as a change in the pattern of capitalization brings about a corresponding change in the overall cost of capital and the total value of the firm. This theory, also known as fixed 'ke' theory, was propounded by David Durand.

The critical assumptions of this theory are:

  1. There are no corporate taxes.
  2. The debt content does not change the risk perception of the investors.
  3. The cost of debt is less than the cost of equity.

The theory works like this. “As the proposition of cheaper debt funds in the capital structure increases, the weighted average cost of capital decreases and approaches the cost of debt. This theory recommends 100% debt financing is optimal capital structure.

The following are the strengths of the NI approach:

  1. it tries to explain the effects of borrowings on the overall cost of capital.
  2. It explains and emphasizes favorable financial leverage.
  3. However, the theory ignores risk consideration.

Thus, Both A) and R) are correct and R) is the right explanation of A.

Related Questions

An assertion and a reason are given below. Assertion: The phenomenon of nuclear fission generates great energy. Reason: The process in which a nucleus is broken into two parts is called nuclear fission. Choose the answer. A. Both Assertion and Reason are true and Reason is the correct explanation of Assertion. B. Both Assertion and Reason are true but Reason is not the correct explanation of Assertion. C. Both Assertion and Reason are false. D. Assertion is true but Reason is false.
Under which of the following approaches, the cost of equity is assumed to increase linearly with leverage, i.e, the average cost of capital remains constant with increased use of leverage?  1. Net Operating Income Approach 2. Net Income Approach 3. Traditional Approach 4. Walter Approach
Given below are two statements. One is labelled as Assertion (A) and the other is labelled as Reason (R).  Assertion (A): If the firm is prepared to incur increased cost on transportation, it may be in a position to reduce its inventory cost  Reason (R) : As in such a case, the firm can use the fastest mode of transport and rush the goods / stocks to the desired warehouse, unmindful of the cost of transportation  In the context of the above two statements related to logistics management, which of the following options is correct  1. Both A) and R) true and R) is the correct explanation of A) 2. Both A) and R) true but R) is NOT the correct explanation of A) 3. A) is true but R) is false 4. A) is false but R) is true 
Direction-The question have two statements.
One is labelled as Assertion (A) and the other as Reason (R). You have to examine both the statements carefully and decide whether Assertion (A) and Reason (R) separately are true and if so then reason is the correct explanation of the assertion. Mark these items on the answer sheet.
Assertion (A): Interest payable on working capital should be treated as an item of operating expenses.
Reason (R): Interest is the cost of capital used in the business.
The following items consist of two statements, one labeled as “Assertion (A)” and the other labeled as the “Reason (R)”. You are to examine the two statements carefully and decide if the Assertion (A) and the Reason (R) are individually true and if so whether the reason is a correct explanation of the assertion. Select your answer to these items using the codes given below and mark your answer accordingly. Assertion (A): In a magnetron, each cavity with its input gap acts as an open circuit transmission line of length half wavelength long. Reason (R): In magnetrons, the usual mode employed is the ‘π’ mode, where the phase change between the adjacent cavities is π radians.
Given below are two statements: Statement I : Deferred Tax Liabilities (Net) is the amount of tax on the temporary difference between the accounting income and taxable income. It arises when the accounting income is more than the taxable income. Statement II : Deferred Tax Liabilities (Net) and Deferred Tax Assets (Net) are only book entries i.e. they are neither actual liability nor actual asset. In the light of the above statements, choose the correct answer from the options given below:
Let D be a simple graph on 10 vertices such that there is a vertex of degree 1, a vertex of degree 2, a vertex of degree 3, a vertex of degree 4, a vertex of degree 5, a vertex of degree 6, a vertex of degree 7, a vertex of degree 8 and a vertex of degree 9. What can be the degree of the last vertex?
Study the following information carefully and answer the question given below. The following criteria have been introduced for the appointment of a scientist in a research organization. Candidates: 1) Must be a postgraduate in Mathematics/Physics/Chemistry subject with a minimum of 65% marks 2) Age should not be less than 26 years and not more than 35 years as on 01-01-2018 3) Must have a post-doctoral degree with more than 50% marks 4) Should have a minimum of 3 years of experience in the above fields 5) Should be prepared to be under probation for one year If the candidate satisfies all the criteria other than (3), he may be designated as Project Scientist. If the candidate satisfies all the above criteria other than (3) and (4) he may be referred for the post of Junior Scientist. If the candidate fulfills all the above criteria with 7 years of experience in the relevant fields, he/she can be designated as a Senior Scientist. If the candidate fulfills all the above criteria with 12 years of experience in the relevant field, he/she can be designated as Principal Scientist. Varun's age is 27 years as of 1/1/18, he obtained his bachelor's and master's degree in chemistry with 72% and 76% marks respectively. He also had 4 years of experience in the relevant field and was ready to be under probation for one year of the job. to what position he may be assigned
In the following question, sentences of a paragraph have been jumbled and labelled as A, B, C, and D. You are required to rearrange the jumbled sentences of the paragraph and mark your response accordingly by selecting the correct option. A: Per capita income (PCI) or average income measures the average income earned per person in a given area (city, region, country, etc.) in a specified year. B: It is calculated by dividing the area's total income by its total population. C: Per capita income is national income divided by population size.  D: Per capita income is often used to measure a sector's average income and compare the wealth of different populations.
The following items consist of two statements, one labeled as “Assertion (A)” and the other labeled as the “Reason (R)”. You are to examine the two statements carefully and decide if the Assertion (A) and the Reason (R) are individually true and if so whether the reason is a correct explanation of the assertion. Select your answer to these items using the codes given below and mark your answer accordingly. Assertion (A): Polarization preserving fibers have a special core design that maintains the state of polarization. Reason (R): In polarization preserving fibers, there is a stress applying part, which creates slow and fast axes in the core.