Debt financing in capital structure, Financial Management

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Net Income approach says that a raise in the proportion of debt financing in capital structure results in an increase in the proportion of a cheaper source of funds. This in turn results in diminishes in overall cost of capital leading to an increase in the value of the firm. The major reasons are:

The assumption of cost of debt to be fewer than the cost of equity.
The interest on debt is a deductible expenditure when the company gets the tax benefits on it.

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