24403553 trading on equity 1
TRANSCRIPT
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Trading on Equity
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Meaning of Trading on Equity
When a co. uses fixed interest bearingcapital along with owned capital in
raising finance, is said Trading on
Equity. (Owned Capital = Equity ShareCapital + Free Reserves )
Trading on equity represents an
arrangement under which a company
uses funds carrying fixed interest or
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Contd.
It is possible to raise the rate ofdividend on equity capital only whenthe rate of interest on fixedinterest
bearingsecurity is less than the rateof return earned in business.
Two other terms:
Trading on Thick Equity :-Whenborrowed capital is less than ownedcapital
Trading on Thin Equity :-When
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Definition
Gerstenberg : When a person or acorporation uses borrowed capital as
well as owned capital in the regular
conduct of its business, he or she issaid to be Trading on equity.
Guthmann and Dougall :The use of
borrowed funds or preferred stock for
financing, is known as trading on
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Contd.
Hast ings:The degree to which debt
is used in acquiring assets is calledTrading on Equity.
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Conditions of success
The rate of interest on borrowed capitalmust be lower than the rate of earnings
on owned capital.
If the capital can be borrowed only onthe security of assets, assets of the
company will gradually be reduced with
every increase in borrowed capital.Trading on equity will weaken the
borrowing capacity of the company.
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Contd.
Trading on Equity can be used only
when companys earnings are stableand certain .
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Limitations
When the rate of interest on borrowed
capital is less than the rate of return
being earned by the company.
It will reduce the borrowing capacity of
the co. as assets are required to place
as security.
Income is more or less fixed are able to
bear the burden of fixed interest
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Contd.
Low proportion of Fixed Assets, havelimited scope of trading on equity.
Legal restrictions on the amount to beborrowed. e.g. it can be borrowed up tothe total amount of paid up share
capital and free reserves only.
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Contd.
The Declining trend of profitability ofbusiness also limits the use of trading on
equity.
Attitude of management restricts the use
of trading on equity.
The nature of companys business may
also restrict the use of trading on equity.
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Useful Suggestions
The rate of dividend on equity share iscalculated.:
Rate of Dividend = Distributable Profit*100
Equity Share Capital If the rate of dividend is not given assumed @
50%
Adjustment regarding transfer to General Reserve
will be given.