Cost of Preference Shares

Cost of Preference Shares Capital: An amount paid by a company as a dividend to preference shareholders is known as the Cost of Preference Share Capital.

A preference share is a small unit of a company’s capital that bears the fixed rate of dividend and the holder of it gets a dividend when the company earns a profit. The dividend payable is not a tax-deductible amount. So, there is no tax adjustments required for comparing with the cost of debt.

The formula for Cost of Preference Shares:

Where,

K_p = Cost of Preference Share

D_p = Dividend on preference share

NP = Net proceeds from the 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 a 5% discount and after 6 years it redeems at a 10% premium. The flotation cost is 5% and the tax rate is 20%. Find out the cost of preference share capital.

Solution:

Dividend on preference share (D_p) = 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

K_p = D_p+ ((RV-NP)/n)/ (RV+NP)/2

= 7200+ ((66,000-54,000)/6) / (66,000+54,000)/2

= 9200/60,000

= 15.33%