A company's earnings before interest and tax is Rs 10 lac. It pays 10% interest on its debt. Total investment of company is Rs. 50 lac.
(a) Advise company whenever it should include debt or equity ot raise its capital.
(b) Name the concept related to this.
(c) Will the company's decision to raise funds from debt or equity will change if company'sEBIT becomes 4 lac.

Explanation

(a) Company should prefer debt to raise fund as debt is gainful for equilty sharesholders till
ROI `gt` Rate of Interest
In the above case ROI`=(EBIT)/(Total Income)xx100=(10)/(50)xx100=20%`
Interest = 10%
14 `gt` 10, so debt is more suitable.
(b) The concept is leverage effect or trading on equity.
(c) Yes company's decision will change if EBIT becomes 4 lac, because with 3 lac ROI will become less than interest.
ROI `=(EBIT)/(Total Income)xx100=(4)/(50)xx100=8%`
Interest = 10%
8%lt10%
So,now company must prefer equity to raise capital.