Question

The Return on Investment (ROI) of a company ranges between 10-12% for the past three years. To finance its future fixed capital needs, it has the following options for borrowing debt:

Option ‘A’: Rate of interest 9%

Option 'B': Rate of interest 13%

Which source of debt, 'Option A’ or 'Option B', is better? Give reason in support of your answer. Also state the concept being used in taking the decision.

Answer 1

Option A - rate of interest 9% is better as it is lesser than ROI which ranges between 10 - 12%. The concept being used in taking the decision is 'Trading on equity' under capital structure which says that if the cost of debt is cheaper, then ROI will be higher and earning per share will increase.