In case of Net Income Approach, when the debt proportion is increased, the cost of debt ___________.

Increases

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Decreases

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Constant

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None of the above

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Solution

The correct option is D Decreases
In case of Net Income Approach, with increase in debt proportion, the total market value of the company increases and cost of capital decreases.
Further, cost of debt is always lower than cost of equity, so with increase in debt finance WACC reduces and value of firm increase.

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Which of the following is the effect on net income, if a business creates a provision for doubtful debts?

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