Net operating income approach

Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses.

1. Net Operating Income Approach By MANAS DHIBAR

2. Introduction While Net Income Approach concluded that Capital Structure makes a difference to the Value of the Firm, the Net Operating Income Approach suggests that value of the firm does not depend upon the Overall Cost of Capital. It is quite opposite to the Net Income Approach. According to which the earnings before interest & taxes determined the Value of the Firm. In this theory the advantage of debt is affected by increase in Equity Capitalisation Rate.

3. V = EBIT Ke E = V – D V = Value of the Firm EBIT = Earning Before Interest & Tax. Ke = Overall Capital Rate D = Debentures E = Overall Cost of Capital

4. Assumptions of This Approach There are no Corporate T axes. The Debt Equity mix does not effect the Overall Cost of Capital. The increase in Debt changes the risk perception of the Shareholder. Overall Cost of Capital is Constant. It is dependent on the business risk which is also constant. Durand explains that when debt increases there is the increase in interest burden of the company & when interest increase shareholders began to expect the higher return from the company. This increases the cost of equity & overall value of the firm does not gain increase in debt proportion of the firm.

5. Example:- Net Operating of the Firm (EBT) = Rs 1,00,000. Overall Capital Rate = 10% Outstanding Debt Rs 2,00,00󠇀0 with 8% Cost of Debt. CASE I . V = 1,00,000 *100/10 = Rs 10,00,000 E = 10,00,000 – 2,00,000 = Rs 8,00,000 Ke = 1,00,000 – 16,000 10,00,000-2,00,000 = 84,000/8,00,000 = 10.5%

6. CASE II . Debentures increases from 2,00,000 to 3,00,000. V = 1,00,000 * 100/10 = Rs 10,00,000 E = V – D = 10,00,000 – 3,00,000 = Rs 7,00,000 Ke = 1,00,000 – 24,000 10,00,000 – 3,00,000 = 76,000 7,00,000 =10.8%

7. CASE III . Debentures decreases to 1,00,000. V = 1,00,000 * 100/10 = Rs 10,00,000 E = 10,00,000 – 1,00,000 = Rs 9,00,000 Ke = 1,00,000 – 8,000 10,00,000 – 1,00,000 = 92,000 9,00,000 = 10.2% Conclusion :- In all the three cases the value of the firm remains the same.

8. Thank You