Question

"The cost of capital declines when the degree of financial leverage increases." Who advocated it?

• A. Net operating income approach
• B. Net income approach
• C. Modigliani-Miller approach
• D. Traditional approach

Answer 1

The correct option is B Net income approach

According to Net income Approach the capital structure decision is relevant to valuation of the firm. This means that a change in financial leverage will automatically lead to corresponding change in overall cost of the capital as well as the total value of the firm. Hence, if the financial leverage increases the weighted average cost of capital decreases and the value of firm and market price of equity share increases and vice versa.