Which concept refers to increase in profits of the Equity shareholders due to the use of Long-term Debts?

Correct option is A

The correct answer is Trading on Equity. Trading on Equity refers to the practice of using borrowed funds (debt) to increase the return on equity shareholders’ investment. When a company earns a rate of return on total capital employed that is higher than the interest it pays on long-term debt, the surplus increases the profits available to equity shareholders. Thus, leveraging debt enhances the earning per share (EPS), benefiting the equity holders. This concept is also known as Financial Leverage or Gearing. Companies use it to magnify profits but must be cautious as excessive debt increases financial risk.
Information Booster
· Trading on Equity works effectively only when Return on Investment (ROI) > Interest rate on debt.
· Higher leverage increases Earnings Per Share (EPS) but also increases financial risk.
· Companies with stable earnings use financial leverage more confidently.
· This concept is crucial in Capital Structure decisions.
· It influences investors’ perception of the firm’s financial strength.