Many of my visitors are Small Business owner so I decided to help them out with simple concept “Trading on Equity“. If you will understand this concept properly than there are some chances that you will be successful in future with your fund management and Good return on your equity in the same and competitive marketing, in which you are operating right now. So Moving ahead, What is Trading on Equity ? ..
Trading on equity simply means you are raising debt at lower cost than your business can earn on that owed funds.Trading on equity occurs when a corporation uses bonds, other debt, and preferred stock to increase its earnings on common stock.
For example, a corporation might use long term debt to purchase assets that are expected to earn more than the interest on the debt. The earnings in excess of the interest expense on the new debt will increase the earnings of the corporation’s common stockholders. The increase in earnings indicates that the corporation was successful in trading on equity.
Let’s Understand the same thing, via One example,
There are two companies, both are operating in the same market, same business and with same capital requirement and same demand competition. Now,
|particulars||Company A||Company B|
|Equity Capital(10 Rs Each)||10,00,000||5,00,000|
|10% Debt Capital||0||5,00,000|
|Earning of Company(%)||18%||18%|
|Earning of Company(Rs)||1,80,000||1,80,000|
|Earning Available to Equity Shares||1,80,000||1,30,000|
|Total Equity Shares||1,00,000||50,000|
|Earning Per Share||1.8 Rs||2.6 Rs|
|Return on Investment (Equity Fund)||18%||26%|
Now, from this you can clearly see that, both the company is operating in the same market then also Company A is making less money than Company B. This is the power of trading on equity.