Page 107 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 6: Cost of Capital

There are different types of preference shares, cumulative and non-cumulative, redeemable and Notes
irredeemable, participating and non-participating, and convertible and non-convertible. But
computation of cost of preference share will be only for redeemable and irredeemable.
Cost of Irredeemable Preference Share/Perpetual Preference Share

The share that cannot be paid till the liquidation of the company is known as irredeemable
preference share. The cost is measured by the following formula:

D
K (without tax) =
p CMP or NP
Where,
K = Cost of preference share
p
D = Dividend per share
CMP = Market price per share

NP = Net proceeds
Cost of irredeemable preference stock (with dividend tax)

D (1+D )
K (with tax) = t
p
CMP or NP
Where,
D = tax on preference dividend
t
Illustration 14:
HHC Ltd., issues 12 per cent perpetual preference shares of face value of 200 each. Compute
cost of preference share (without tax).
Solution:

D
K = ×100
p NP
= 12 per cent
Illustration 15: (with dividend tax)
A company is planning to issue 14 per cent irredeemable preference share at the face value of
250 per share, with an estimated flotation cost of 5%. What is the cost of preference share with
10% dividend tax.

Solution:

D (1+D )
K = t ×100
p
NP
35 (1+0.10 )
= ×100 =16.21 per cent
237.5
Illustration 16:
Sai Ram & Co. is planning to issue 14 per cent perpetual preference shares, with face value of
100 each. Floatation costs are estimated at 4 per cent on sales price. Compute (a) cost of

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