CA Inter P6 · Chapter 5 · Question 2 of 9
Under the Net Operating Income (NOI) approach, a firm has EBIT of ₹ 8,00,000 and an overall capitalisation rate of 12.5%. It has 9% debt of ₹ 24,00,000. Ignoring taxes, the implied cost of equity is:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) 14.6%
Explanation
Value of firm V = EBIT / Ko = ₹ 8,00,000 / 0.125 = ₹ 64,00,000. Value of equity = ₹ 64,00,000 - ₹ 24,00,000 = ₹ 40,00,000. Earnings for equity = ₹ 8,00,000 - ₹ 2,16,000 = ₹ 5,84,000. Ke = ₹ 5,84,000 / ₹ 40,00,000 = 14.6%. Under NOI, Ke rises with leverage while Ko stays constant at 12.5%.
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