ABC Ltd. has debt equity ratio of 3:1, whereas XYZ Ltd. has debt equity ratio of 1:1. Name the advantage ABC Ltd will have over XYZ Ltd., when the rate of interest is lower than the rate of return on investment of the company.

Trading on Equity

The correct answer is option 1- Trading on Equity.

Trading on Equity is the advantage ABC Ltd will have over XYZ Ltd.

Trading on Equity refers to the advantage a company gains when it uses debt financing (borrowed funds) instead of equity, and the return on investment (ROI) is higher than the interest rate on that debt. ABC Ltd. has a higher debt-equity ratio (3:1), meaning it relies more on debt. If the rate of return exceeds the cost of debt (interest rate), ABC Ltd. earns more for shareholders because it uses cheaper debt to finance profitable investments. This magnifies returns to equity shareholders, which is exactly what Trading on Equity means.