Calculation of Cost of Preference Share Capital

1. Issuance at Par Value
Cost of preference share capital = Dividend / Net Proceeds x (1 - Tax Rate)

Dividend = 10% of Rs. 100 = Rs. 10
Net Proceeds = Rs. 100 - Rs. 3 = Rs. 97
Tax Rate = 50%

Cost of preference share capital = Rs. 10 / Rs. 97 x (1 - 0.5) = Rs. 0.10 / Rs. 0.485 = 20.62%

2. Issuance at 5% Discount
Cost of preference share capital = Dividend / Net Proceeds x (1 - Tax Rate)

Dividend = 10% of Rs. 100 = Rs. 10
Net Proceeds = (Rs. 100 - Rs. 3) x (1 - 0.05) = Rs. 94.05
Tax Rate = 50%

Cost of preference share capital = Rs. 10 / Rs. 94.05 x (1 - 0.5) = Rs. 0.10 / Rs. 0.47025 = 21.22%

3. Issuance at 10% Premium
Cost of preference share capital = Dividend / Net Proceeds x (1 - Tax Rate)

Dividend = 10% of Rs. 100 = Rs. 10
Net Proceeds = (Rs. 100 - Rs. 3) x (1 + 0.1) = Rs. 106.70
Tax Rate = 50%

Cost of preference share capital = Rs. 10 / Rs. 106.70 x (1 - 0.5) = Rs. 0.10 / Rs. 0.5335 = 18.72%

Explanation

Cost of preference share capital is the rate of return required by the preference shareholders for investing in the company. It is calculated by dividing the preference dividend by the net proceeds and adjusting for the tax rate.

In this case, Sita ltd. issued 1,000 10% preference shares of Rs. 100 each at a cost of Rs. 3 per share. The cost of preference share capital was calculated for three scenarios - issuance at par value, issuance at a 5% discount, and issuance at a 10% premium.

The cost of preference share capital was highest in the case of issuance at a discount, as the net proceeds were lower. Conversely, the cost of preference share capital was lowest in the case of issuance at a premium, as the net proceeds were higher.

The tax rate was also taken into account, as preference dividend is tax-deductible. A higher tax rate would result in a lower cost of preference share capital, as the tax shield would be greater.

Overall, the cost of preference share capital is an important metric for companies looking to raise funds through preference shares. It helps them determine the rate of return required by investors and ensures that the funds raised are cost-effective.