CBSE Class 12-commerce Answered
A company’s earnings before interest and tax is Rs. 7 lac. It pays 10% interest on its debt. Total investment of company is rs. 50 lac. 1. Advise company whenever it should include debt or equity to raise its capital. 2. Name the concept related to this. 3. Will be company’s decision to raise funds from debt or equity will change if company’s EBIT becomes 3 lac.
Asked by purnayyap | 26 Apr, 2020, 12:11: PM
Expert Answer
Debt is considered as gainful for equity shareholders till ROI>Rate of Interest. In the given case,
ROI is 14% i.e., 7,00,000/50,00,000 * 100 and
Rate of Interest is 10%
That is ROI>Rate of Interest and therefore, in the given case also the company should prefer debt to raise fund
The concept related to the given case is Trading on Equity (also known as the Leverage effect)
If company's EBIT is 3,00,000,
ROI will be 6% i.e., 3,00,000/50,00,000 * 100 and
Rate of Interest is 10%
That is, ROI<Rate of Interest and therefore, the company should prefer equity to raise fund
Answered by Surabhi Gawade | 26 Apr, 2020, 01:31: PM
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