The document outlines the concept of preference capital and its cost, explaining how to calculate the cost based on different scenarios: at par, premium, and discount. It provides detailed examples of calculations for companies issuing preference shares, taking into account factors such as flotation costs and redemption value. Additionally, it discusses the implications of not paying dividends on preference shares and their effect on a company's fundraising capacity.

1. FINANCIAL MANAGEMENT
COST OF CAPITAL
BY:
SMT.UMA MINAJIGI REUR
HEAD, DEPT. OF COMMERCE& MANAGEMENT
SMT. V G DEGREE COLLEGEFOR WOMEN, KALABURAGI

2. COST OF PREFERENCE CAPITAL

3. Cost of Preference Capital
A fixed rate of dividend is payable on preference shares. But payment of dividend is
no legal binding. It is generally paid whenever the company makes sufficient
profits.
If dividend is not paid to the preference shareholders it will affect the fund raising
capacity of the company. Hence, dividends are regularly paid on preference shares
except when there is no profits to pay dividends.

4. • The Preference Capital carries a cost. The Cost of Preference Capital is
calculated as follows:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend
P = Net Proceeds

5. Preference Shares may be issued at Par, Premium, Discount.
When Preference Shares are issued at Par:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend
P = Net Proceeds
P = Net Proceeds = Face Value – Floatation Costs

6. When Preference Shares are issued at Premium:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend
P = Net Proceeds
P = Net Proceeds = Face Value + Premium – Floatation Costs

7. When Preference Shares are issued at Discount:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend
P = Net Proceeds
P = Net Proceeds = Face Value - Discount – Floatation Costs

8. 23. A company issues 20,000 10% preference shares of Rs.100 each. Cost of issue is Rs.2 per
share. Calculate cost of preference capital, if these are issued :
a. at par
b. at a premium of 10%
c. at a discount of 5%.
Solution:
a. When Preference Shares are issued at Par:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend = 10% (20,00,000 * 10/100 = 2,00,000)
P = Net Proceeds
P = Net Proceeds = Face Value – Floatation Costs
= 20,00,000 – 40,000
= 19,60,000
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
𝐾𝑝 =
2,00,000
19,60,000
∗ 100
𝑲𝒑 = 𝟏𝟎. 𝟐𝟎%

9. b. When Preference Shares are issued at Premium:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend = 10% (20,00,000 * 10/100 = 2,00,000)
P = Net Proceeds
P = Net Proceeds = Face Value + Premium – Floatation Costs
= 20,00,000 + 10% of 20,00,000 – 40,000
= 20,00,000 + 2,00,000- 40,000
= 21,60,000
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
𝐾𝑝 =
2,00,000
21,60,000
∗ 100
𝑲𝒑 = 𝟗. 𝟐𝟔%

10. c. When Preference Shares are issued at Discount:
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
Where,
Kp = Cost of Preference Capital
R = Rate of Dividend = 10% (20,00,000 * 10/100 = 2,00,000)
P = Net Proceeds
P = Net Proceeds = Face Value - Discount – Floatation Costs
= 20,00,000 - 5% of 20,00,000 – 40,000
= 20,00,000 - 1,00,000- 40,000
= 18,60,000
Cost of Preference Capital
𝐾𝑝 =
𝑅
𝑃
𝐾𝑝 =
2,00,000
18,60,000
∗ 100
𝑲𝒑 = 𝟏𝟎. 𝟕𝟓%

11. 24. A company raised preference share capital Rs.5,00,000 by
issue of 10% preference shares of Rs.10 each. Calculate the cost
of preference capital when they are issued at:
a. at par
b. at 10% premium
c. at 10% discount.

12. Cost of Redeemable Preference Shares
Redeemable preference shares are issued which can be redeemed or
cancelled on maturity date. The cost of Redeemable preference
share is calculated as follows:
𝑲𝒑 =
𝑹 +
𝑴𝑽 − 𝑷
𝑵
𝑰
𝟐
(𝑴𝑽 − 𝑷)
Where,
Kp = Cost of Redeemable preference Capital
R = Dividend Rate
N = Number of years to maturity
MV = Maturity value of preference shares
P = Net Proceeds

13. 25. A company issues 20,000, 10% preference shares of Rs.100 each redeemable after 10 years at a
premium of 5%. The cost of issue is Rs.2 per share. Calculate the cost of preference capital.
Solution:
𝑲𝒑 =
𝑹 +
𝑴𝑽 − 𝑷
𝑵
𝑰
2
𝑴𝑽 + 𝑷
Where,
Kp = Cost of Redeemable preference Capital
R = Dividend Rate = 10% of 20,00,000 = (20,00,000 *10/100) = 2,00,000
N = Number of years to maturity = 10 years
MV = Maturity value of preference shares =
= Face Value + Premium
= 20,00,000 + 5% of 20,00,000
= 20,00,000 + 1,00,000
= 21,00,000
P = Net Proceeds = Face Value - Cost of issue
= 20,00,000 – 40,000
= 19,60,000

14. 𝑲𝒑 =
𝟐, 𝟎𝟎, 𝟎𝟎𝟎 +
𝟐𝟏, 𝟎𝟎, 𝟎𝟎𝟎 − 𝟏𝟗, 𝟔𝟎, 𝟎𝟎𝟎
𝟏𝟎
𝑰
𝟐
(𝟐𝟏, 𝟎𝟎, 𝟎𝟎𝟎 + 𝟏𝟗, 𝟔𝟎, 𝟎𝟎𝟎)
𝑲𝒑 =
𝟐, 𝟎𝟎, 𝟎𝟎𝟎 +
𝟏, 𝟒𝟎, 𝟎𝟎𝟎
𝟏𝟎
𝑰
𝟐
(𝟒𝟎, 𝟔𝟎, 𝟎𝟎𝟎)
𝑲𝒑 =
𝟐, 𝟏𝟒, 𝟎𝟎𝟎
𝟐𝟎, 𝟑𝟎, 𝟎𝟎𝟎
Kp = 0.1054 * 100
Kp = 10.54%

15. 26. A company issues 20,000 7% preference shares of Rs.10 each
at a premium of 10% redeemable after 5 years at par. Compute the
cost of preference capital.
27. A company issues 10,000 10% preference shares of Rs.10 each
redeemable at the end of the 10th year. From the year of their issue.
The underwriting costs comes to 2%. Calculate the effective cost of
preference share capital.

16. THANK YOU