Cost of Preference Capital Soved Problems-kp

The Preference Capital carries a cost. The Cost of Preference Capital is calculated as follows:
Preference Shares may be issued at Par, Premium, Discount.
Cost of Redeemable Preference Shares

1. FINANCIAL MANAGEMENT COST OF CAPITAL By: Smt.UMA MINAJIGI REUR HEAD, DEPT. OF COMMERCE & Management Smt. V G Degree College for 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   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   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   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   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:   When Preference Shares are issued at Par:   Cost of Preference Capital   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        

9. When Preference Shares are issued at Premium:   Cost of Preference Capital   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        

10. When Preference Shares are issued at Discount:   Cost of Preference Capital   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        

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:   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:   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 = 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 10 th year. From the year of their issue. The underwriting costs comes to 2%. Calculate the effective cost of preference share capital.

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