Cost of Preference Shares18/05/2020
Cost of Preference Share Capital: An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital.
Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt.
Formula for Cost of Preference Share:
Irredeemable Preference Share
Redeemable Preference Share
Kp = Dp/NP
Kp = Dp+((RV-NP)/n )/ (RV+NP)/2
Kp = Cost of Preference Share
Dp = Dividend on preference share
NP = Net proceeds from issue of preference share
(Issue price – Flotation cost)
RV = Redemption Value
N = Period of preference share
Example: A preference share issues at 12% worth Rs 60,000 at 5% discount and after 6 years it redeem at 10% premium. The flotation cost is 5% and tax rate is 20%. Find out the cost of preference share capital.
Dividend on preference share (Dp) = 60,000*12/100 = Rs.7200
Discount = 60,000*5/100 = Rs.3000
Flotation Cost = 60,000*5/100 = Rs.3000
Net Proceeds (NP) = Rs. (60,000-3000-3000) = Rs. 54,000
Premium amount = 60,000*10/100 =Rs. 6000
Redemption Value = Rs. (60,000+6000) = Rs. 66,000
Kp = Dp+ ((RV-NP)/n)/ (RV+NP)/2
= 7200+ ((66,000-54,000)/6) / (66,000+54,000)/2