Cost of Preference Share Capital

The cost of preference share capital is apparently the dividend which is committed and paid by the company. This cost is not relevant for project evaluation because this is not the cost at which further capital can be obtained. To find out the cost of acquiring the marginal cost, we will be finding the yield on the preference share based on the current market value of the preference share.

The preference share is issued at a stated rate of dividend on the face value of the share. Although the dividend is not mandatory and it does not create legal obligation like debt, it has the preference of payment over equity for dividend payment and distribution of assets at the time of liquidation. Therefore, without paying the dividend to preference shares, they cannot pay anything to equity shares. In that scenario, management normally tries to pay a regular dividend to the preference shareholders.

Broadly, preference shares can be of two types – Redeemable and Irredeemable.

Cost of Preference Share CapitalCost of Redeemable Preference Shares

These shares are issued for a particular period and at the expiry of that period, they are redeemed and principal is paid back to the preference shareholders. The characteristics are very similar to debt and therefore the calculations will be similar too. For finding cost of redeemable preference shares, following formula can be used.

Cost of Preference Share Formula

Cost of Preference Share Formula

Here, preference share is traded at say P0 with dividend payments ‘D’ and principal repayment ‘P’. The cost of debt is designated by Kp. Kcan be determined by solving above equation.

Explanation of cost of redeemable preference capital with example:

For example, a firm had on the balance sheet, a 9% preference stock which matures after 3 years. The face value is 1000. Putting the formula when current market price of the debenture is 950, we get,Cost of Preference Share Formula

Solving the above equation, we will get 11.05%. This is the cost of preference share capital. In the case of debt, it would have required further adjustment with respect to tax because debt enjoys tax shield. Preference dividend is paid out of profits and not treated as an expense for the company. Rather it is called profit distribution.

Cost of Irredeemable Preference Shares

These shares are issued for the life of the company and are not redeemed. Cost of irredeemable preference shares can be calculated as follows:

Here, preference share is traded at say P0 with dividend payments ‘D’. The cost of debt is designated by Kp. Kcan be determined by solving above equation.

Cost of Preference Share Formula

Cost of Preference Share Formula

Explanation of cost of irredeemable preference capital with example:

For example, a firm issued a 10% preference stock of $1000 which has a current market price of $900. Cost can be calculated as below:

Kp = 100/900

Solving the above equation, we will get 11.11%. This is the cost of redeemable preference share capital.

Last updated on : August 31st, 2017
What’s your view on this? Share it in comments below.


  1. ASA
  2. Meenakshi

Leave a Reply

Tobin’s Q / Q Ratio
  • Beta
  • Why Net Present Value is the Best Measure for Investment Appraisal
    Why Net Present Value is the Best …
  • Types of Weights for WACC
    Market vs. Book Value WACC
  • Advantages and Disadvantages of Sensitivity Analysis
    Advantages and Disadvantages of Sensitive Analysis
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Recent Posts

    Find us on Facebook

    Related pages

    creditor turnover ratiopreference shareholders rightsvertical analysis calculationzero coupon bond vs coupon bonddisadvantages of borrowing moneygoodwill balance sheet classificationadverse or favourable varianceddm definitioncalculate yield to maturity formulamotives for mergerswhat is preference share capitalzbb budgetingdef liabilitydefinition of capital budgeting in financial managementcalculation for payback perioddiscounting bill of exchangecapitalizing interestfinance waccwacc estimationmirr reinvestment approachintangible asset impairment testadvantages and disadvantages of retained profitwru debentureszero base costingdiscounted cash flow method for valuation of shareseoq inventory managementwacc calculation examplesinventories turnover dayspros and cons of issuing bondszero based budgeting advantages and disadvantagesaccounting debit definitionfactors of macro environmentnon marketable financial assetrevaluation definitionequity theory advantages and disadvantageshow to calculate mirrmeaning of profitability indexzbb zero based budgetingcons of budgetinghow to calculate project payback periodweighted average cost of capital waccdebts to total assets ratioredeemable preference sharediscounted payback rulenwc calculationaccounting inventory turnover ratioprofitability ratio definitionraw material turnoverbudgetary control system advantagescapital lease ifrstod letter for bankirr manual calculationconservative approach to financing working capitalequation of irrinventory management eoqexplain eoqdividend irrelevancyfundamental accounting equation examplestypes of convertible bondsadr currencymarket value of debt waccactivity ratios formuladefine receivables turnoverrate of stock turnover formulahypothecation agreement meaninginstallments meaningadvantage of activity based costingwhat is a callable bondaccounting for research and development gaapliquid ratio calculatoraccounts receivable turnover ratetrade debtors accounts receivablewhat is marginal costing in management accountinghow to calculate debtorsfactors affecting the dividend policydebtors ratiosrevocable letter of credit and irrevocable letter of creditcompute weighted average cost of capitallimitations of activity based costing