Cost of Preference Share Capital

Introduction:
Preference shares are a type of shares that carry a fixed dividend rate and have a higher claim on the company's assets and earnings compared to common shares. The cost of preference share capital refers to the cost incurred by a company to raise funds through the issuance of preference shares.

Cost of Preference Share Capital Calculation:
The cost of preference share capital can be calculated using the formula:

Cost of Preference Share Capital = Dividend Rate / Net Proceeds from Issue of Preference Shares

Where,
Dividend Rate = Annual Dividend per Preference Share / Issue Price per Preference Share
Net Proceeds from Issue of Preference Shares = Issue Price per Preference Share - Cost of Issue

(a) Issued at Par:
When preference shares are issued at par, the issue price is equal to the face value of the shares. In this case, the cost of preference share capital can be calculated as follows:

Dividend Rate = 8% of Rs. 100 = Rs. 8
Cost of Issue = Rs. 2 per share
Net Proceeds from Issue of Preference Shares = Rs. 100 - Rs. 2 = Rs. 98

Cost of Preference Share Capital = Rs. 8 / Rs. 98 = 0.0816 or 8.16%

(b) Issued at a Premium of 10%:
When preference shares are issued at a premium, the issue price is higher than the face value of the shares. In this case, the cost of preference share capital can be calculated as follows:

Issue Price per Preference Share = Face Value + Premium
= Rs. 100 + (10% of Rs. 100) = Rs. 100 + Rs. 10 = Rs. 110

Dividend Rate = 8% of Rs. 100 = Rs. 8
Cost of Issue = Rs. 2 per share
Net Proceeds from Issue of Preference Shares = Rs. 110 - Rs. 2 = Rs. 108

Cost of Preference Share Capital = Rs. 8 / Rs. 108 = 0.0741 or 7.41%

(c) Issued at a Discount of 6%:
When preference shares are issued at a discount, the issue price is lower than the face value of the shares. In this case, the cost of preference share capital can be calculated as follows:

Issue Price per Preference Share = Face Value - Discount
= Rs. 100 - (6% of Rs. 100) = Rs. 100 - Rs. 6 = Rs. 94

Dividend Rate = 8% of Rs. 100 = Rs. 8
Cost of Issue = Rs. 2 per share
Net Proceeds from Issue of Preference Shares = Rs. 94 - Rs. 2 = Rs. 92

Cost of Preference Share Capital = Rs. 8 / Rs. 92 = 0.087 or 8.7%

Conclusion:
The cost of preference share capital can be calculated based on the dividend rate, issue price, and cost of issue. Depending on whether the shares are issued at par, at a premium, or at a discount, the cost of preference share capital will vary. It is important for companies to consider the cost of capital when making