वित्तीय प्रबंध (Financial Management)

Trading on Equity refers to the practice of including fixed-cost debt instruments (debentures or loans) in the capital structure to increase the Earnings Per Share (EPS) of equity shareholders.
Mathematical Condition: Financial leverage is favorable ONLY when the Return on Investment (ROI) is strictly greater than the Cost of Debt (Interest Rate):

$$\text{ROI} > \text{Interest Rate}$$

When this holds true, the firm earns more on the borrowed capital than the interest it pays to lenders; the surplus profit flows entirely to the equity shareholders, multiplying EPS.

Profit maximization is a narrow, short-term accounting concept that suffers from two major flaws: (1) It ignores the Time Value of Money (receiving ₹10 lakhs today is far better than receiving ₹10 lakhs 5 years later), and (2) It ignores Financial Risk (high profits can be generated by reckless, dangerous borrowing that risks bankruptcy).
Shareholders' Wealth Maximization focuses on maximizing the Market Price of the company's Equity Shares, which accounts for profitability, cash flows, growth timing, and financial risk.

• Case A (All Equity - 3,00,000 shares of ₹10):
EBIT: ₹4,00,000
Less: Interest: ₹0
EBT: ₹4,00,000
Less: Tax @ 30%: ₹1,20,000
EAT: ₹2,80,000

$$\text{EPS} = \frac{₹2,80,000}{3,00,000\text{ shares}} = ₹0.93\text{ per share}.$$

• Case B (₹10L Equity [1,00,000 shares] + ₹20L 10% Debt):
EBIT: ₹4,00,000
Less: Interest (10% of 20L): ₹2,00,000
EBT: ₹2,00,000
Less: Tax @ 30%: ₹60,000
EAT: ₹1,40,000

$$\text{EPS} = \frac{₹1,40,000}{1,00,000\text{ shares}} = ₹1.40\text{ per share}.$$

Conclusion: Because $\text{ROI } (13.33\%) > \text{Cost of Debt } (10\%)$, EPS jumped from ₹0.93 to ₹1.40—a 50% increase!

• Interest Coverage Ratio (ICR): $\frac{\text{EBIT}}{\text{Interest}}$. Measures only how many times operating profit covers the annual interest obligation.
• Debt Service Coverage Ratio (DSCR): $\frac{\text{Cash Profit Available for Debt Service}}{\text{Interest} + \text{Principal Repayment}}$. Evaluates total cash flow against both interest and principal loan installments.
Why Banks Prefer DSCR: A company can show high accounting profit (high ICR) while suffering from a severe cash shortage due to uncollected debtors. DSCR measures actual cash available to repay debt principal, providing banks with a true safety metric.

1. Length of Operating Cycle: A long production cycle (e.g., aging wine or manufacturing heavy machinery) ties up cash in work-in-progress for months, requiring large working capital; a short cycle (e.g., bakery) requires minimal working capital.
   2. Credit Allowed to Customers: A liberal credit policy (90 days credit) increases debtors, requiring higher working capital; a cash-only policy reduces working capital.
   3. Business Cycle Fluctuations: During economic booms, sales expand rapidly, demanding higher working capital to maintain larger inventory and debtor books.

1. Long-Term Financial Impact: Capital budgeting commitments (e.g., spending ₹500 crore on an oil refinery) determine the company's growth, cost structure, and profitability for decades.
   2. Massive Capital Outlay: Requires huge financial resources that cannot be easily retrieved.
   3. Irreversibility: Once specialized plant and equipment are installed, reversing the decision involves massive capital write-offs and catastrophic financial losses.

A higher corporate income tax rate makes Debt financing significantly more attractive. Because interest paid on debt is a tax-deductible expense, a higher tax rate increases the tax shield savings. For example, at a 40% tax rate, a 10% debenture effectively costs the company only $10\% \times (1 - 0.40) = 6\%$, whereas equity dividends provide zero tax shield.

If a company has abundant lucrative growth and capital expansion opportunities (e.g., expanding into high-margin electric vehicles or cloud computing), it requires massive investment funds. Under the Dividend Decision, the company will choose to retain a larger percentage of its profits (lower dividend payout) to reinvest internally, avoiding expensive external borrowing. Conversely, mature companies with few growth prospects distribute higher dividends.