Q. How does "Trading on Equity" affect the choice of capital structure or a company. Explain with the help of suitable example.
Situation 1
Total Capital - Rs. 50 lakhs
Equity - Rs. 50 lakhs (4 lakhs share of Rs. 10 each)
Debt - Nil
Tax rate - 30%
E BIT - 7 Lakhs
Situation 2.
Total Capital - Rs. 50 lakhs
Equity - Rs. 40 lakhs (4 lakhs share of Rs. 10 each)
Debt - 10 lakhs
Tax rate - 30% p.a
Interest on debt - 10%
E BIT - 7 Lakhs
Situation. 3
Total Capital - Rs. 50 lakhs
Equity - Rs. 30 lakhs
Debt - Rs. 20 lakhs
Tax rate - 30% p.a
Interest on debt - 10%
E BIT - 8 lakhs
Dear student,
Your answer is correct.
The debt content in capital increases the Earning per share, but it does not mean that company should entirely go with debt. A company should maintain a proper ratio between Debt and Equity.
Regards
Your answer is correct.
The debt content in capital increases the Earning per share, but it does not mean that company should entirely go with debt. A company should maintain a proper ratio between Debt and Equity.
Regards