Final answer:
False,According to the NOI approach, the assertion that a firm can increase its total valuation and reduce its cost of capital by increasing financial leverage is false. The cost of debt and equity adjusts in such a way that the overall cost of capital remains unchanged, irrespective of the firm's leverage.
Step-by-step explanation:
According to the Net Operating Income (NOI) approach, it is false that a firm can increase its total valuation and lower its cost of capital as it increases the use of financial leverage.
The NOI approach posits that the market capitalizes the value of the firm as a whole based on the risk of its underlying business and that the use of debt does not change the overall firm risk.
Therefore, the cost of equity increases with more debt because equity holders demand a higher return for the increased risk.
The increased cost of equity offsets the advantages of the lower cost of debt, keeping the overall cost of capital the same regardless of the leverage level.
Early-stage corporate finance often involves raising money from private investors, as very small companies may not have the necessary resources or the appeal to conduct an Initial Public Offering (IPO).
Small, young companies may prefer an IPO over borrowing through bank loans or issuing bonds because an IPO can provide more capital for growth and the public market valuation can exceed what private investors might offer.
When it comes to assessing the profitability of a small firm, a venture capitalist usually has better information than a potential bondholder because venture capitalists often take an active role in management and have access to internal information about the firm's operations and potential.
From a firm's view, a bond is similar to a bank loan in the sense that they both involve borrowing money that must be repaid with interest.
However, they are different as a bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental), while a bank loan is typically a more flexible credit facility with terms that can be renegotiated.
For Fred, who bought a house for $200,000 with a 10% down payment: Fred's equity in his home is $20,000. This is calculated by taking the down payment percentage (10%) and applying it to the home purchase price (200,000 * 0.10 = $20,000).