Page 69 - DMGT409Basic Financial Management

Basic Financial Management

Notes Illustration 9: The Capital Ltd., wishes to calculate its cost of equity capital using the Capital
Asset Pricing Model (CAPM) approach. Company’s analyst found, that its risk free rate of return
equals 12 per cent beta equal equals 1.7 and the return on market portfolio equals 14.5 per cent.
Solution:

K = R + (R – R ) β = 12 + [14.5 - 12] 1.7
e f mf f
= 12 + 4.25 = 16.25 per cent

Task A company’s earnings available to ordinary shareholders is ` 5,00,000. It has capital
` 50,00,000, face value of ` 100 each. The company’s share is selling at ` 200. Compute cost
of equity (Assuming 100% dividend payout ratio).

4.3.2 Cost of Preference Shares

The preference share is issued by companies to raise funds from investors.
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Did u know? Preference share has two preferential rights over equity shares, (i) preference
in payment of dividend, from distributable profits, (ii) preference in the payment of capital

at the time of liquidation of the company.
There are different types of preference shares, cumulative and non-cumulative, redeemable and
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 Dt+ )
K (without tax) =
p CMP or NP
Where,
Dt = tax on preference dividend

Illustration 10: HHC Ltd., issues 12 per cent perpetual preference shares of face value of ` 200
each. Compute cost of preference share (without tax).

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