Page 108 - DMGT207_MANAGEMENT_OF_FINANCES

Unit 5: 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 16: 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
24
K = ×100 = 12 per cent
p
200
Illustration 17: (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 18: 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 preference shares if they are issued at (i) face/par value, (ii) 10 per cent premium, and
(iii) 5 per cent discount, (b) compute cost of preference share in these situation assuming 5 per
cent dividend.

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