Trading on equity is technique in which a company gets fund from debt sources or borrowing and company knows that his return on investment is more than fixed interest charges. With this earning per share becomes highest without any risk of bankruptcy or fear of high cost of capital. This technique was used in uk first after industrial revolution and professional finance manager guides company, how can company increase E P S without decentralizing of powers.
Condition of trading on equity:-
- R O I >fixed interest charges
- Company get loan and utilize it in business.
- Major part of capital structure must be long term loan.
Benefit of trading on equity:-
Main benefit is to owner of company because if company gets loan at loaner rate, EPS will increase and it will increase also dividend per share and value of share.
Different between trading on equity& equity trading:-
Trading on equity is just technique in which proportion of debt contents are increased in capital structure but equity trading is sale and purchase of shares in stock market. investor are interested to buy those shares whose R O I is more than fixed interest charges because investor can excess amount of profit in the form of dividend and it will also increase the price of shares.
Trading on equity v/s financial leverage:-
If a company buys asset and its purchase price is paid by getting loan, then this system of trading on equity is called financial leverage. If we read the meaning of leverage, it means power. Because company knows R O I is more than fixed interest charges, then company’s board of directors tries to increase their financial power by purchasing all assets with the help of long term debt and increase their profit with this system.