Explain trade of equity in capital structure.

The word trading means profit earning and equity means owner’s money. In other words, trade of equity means profit is earned through owner’s money. Company will go for trade on equity, when it needs new debt to gain or acquire new assets on which, it can earn high return as compared to normal interest on cost of debt. New debts are issued in the form of bonds, loans or preferred stocks.

Objectives are described below −

  • To operate its own trade.
  • Increase rate of dividends.
  • Control source of finance.
  • Increase reputation of a company.

Types are as follows −

  • Tiny equity − Share capital is less than debt capital.
  • Thick equity − Share capital is more than debt capital.

Advantages are given below −

  • It enhances earnings.
  • Operation of trading is regular.
  • It pays high dividends rates.
  • Tax burden is minimised.
  • Intangible asset (goodwill) of a company increases.
  • Source of finance is controlled.
  • Centralised voting power.

Disadvantages are explained below −

  • No regular/stable income.
  • Reduces rate of return.
  • Management support is limited.
  • High interest rates.
  • Company can become overcapitalised.
  • It can arise legal constraints.

Updated on: 25-Sep-2020


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