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International Institute for Special Education (IISE)

Presentation on Cost of Preference Shares.

By,
Ravi Srivastava
Financial Management:
Meaning

It simply explains the management of the Finance.


Two basic principles involved in Financial Management
are :
(a)Procurement of Funds.
(b) Utilization of Funds.
i.e. how to arrange and utilize the finance.
Two types of funds are involved –
(a)Long term sources of funds, i.e. Equity Share Capital,
Preference Share Capital, Debentures, Term Loans etc.
(b)Short term sources of funds, i.e. Trade Credit , Bank
Credit, Commercial Papers, Factoring ,Short Term
Public Deposits etc.
Cost of Capital
The cost of capital is an important factor for
designing the capital structure of a firm. The
basic reasons for running a firm is to earn a
return at least equal to its cost of capital.
It comprises various parts, like Cost of Equity,
Cost of Debentures, Cost of Preference
Shares, Cost of Retained Earnings, etc.
A business should earn enough revenue to
meet its cost of capital and finance its growth.
Finance Manager should consider the cost
carefully while designing the capital structure.
Cost of Preference
Shares
Meaning of Preference Shares:
,
Preference Shares is one which carries the
following two rights:
(i) Right to receive dividend at a stipulated rate
before any dividend is paid to equity
shareholders,
(ii) Right to receive repayment of capital on
winding up of the company before the capital of
equity shareholders is returned.
Classification:
(i) Cumulative Preference Shares
(ii) Non-Cumulative Preference Shares
(iii) Participating Preference Shares
(iv) Non- Participating Preference Shares
(v) Convertible Preference Shares
(vi) Non- Convertible Preference Shares
(vii) Redeemable Preference Shares
(viii) Irredeemable Preference Shares
Cost of Preference Shares:
For preference shares, the dividend rate can be
considered as its cost as it is this amount which the
company wants to pay against preference shares.
If floatation cost occurs at the time of Issue and
Redemption, it will be substracted from RV or NP, as
the case may be.
Cost of Irredeemable Preference Shares -
 PD
 Kp = --------- x 100
 NP
 where, PD = Annual Preference Dividend.
 NP = Net Proceeds of issue of preference
shares.
Cost of Redeemable Preference
Shares:
If preference shares are redeemable after a fixed
period, then the cost of preference shares will be –

 PD + (RV – NP)/N
 Kp = ----------------------------- x 100
 (RV + NP) /2
where,
RV = Redemption value which is to be paid to the

 Preference Shareholders
NP = Net Proceed at the time of issue of Preference
 Shares
 N = Life or Redemption Period.
Q. 1 A co. issued 20,000 12%
Preference Shares of Rs. 100 each at
par. Calculate Kp.

Here –
PD = 12% of ( 20,000 x Rs. 100)
= 2,40,000
NP = 2,00,000
2,40,000
Kp = ------------------ x 100
 2,00,000

 = 12%
Shares of face value Rs. 100 each carrying
14% dividend and realize Rs. 92 per share.
The shares are repayable after 12 years at
par. Calculate Kp.
Here:
PD = 14
NP = 92
RV = 100
 14 + (100 – 92) / 12
 Kp = ----------------------------- x 100
 (100 + 92) / 2

 = 15.27%
Thank You

Regards

Ravi Srivastava

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