Question

Benefit of 'Trading on Equity' is available only if .

• A. Rate of interest < Rate of return
• B. Rate of interest > Rate of return
• C. Both A and B
• D. None of A and B

Answer 1

The correct option is A Rate of interest < Rate of return

In Trading on Equity, also known as financial leverage what happens is that the company uses its own equity capital as well as borrowed funds or only borrowed funds to increase its operational capacity. The management is certain that the increase in returns from the expansion would be more than the increase in interest cost.

For Example: A Ltd purchases an asset for Rs.1,00,000Rs.100000 using amount raised from issue of debentures on which interest has to paid @ 1010% and the return from the asset is 15%.1% , here the Rate of Interest<Rate of Return and the benefit of trading on equity is reflected in the form of incremental return of $5$%.