Question

Which one is true for Net Operating Income Approach?

• A. $V_D$ = $V_F$ - $V_E$
• B. $V_E$ = $V_F$ + $V_D$
• C. $V_E$ = $V_F$ - $V_D$
• D. $V_D$ = $V_F$ + $V_E$

Answer 1

The correct option is C $V_E$ = $V_F$ - $V_D$

Net operating income is capitalized at an overall capitalization rate to obtain the total market value of the firm. The market value of the debt then is deducted from the total market value to obtain the market value of the stock.

Cost of debt = Interest market value of debt,

Cost of equity = Earnings available to shareholders market value of shares outstanding

Market value of the equity = Value of the firm - Market value of the debt

$V_E=V_F-V_D$