Cost of Preference Share
The cost of preference share is stated annual dividend rate and is calculated in a manner similar to that used for debentures. This rate is however, not adjusted for income taxes. Unlike debt. preference dividend payment is subject to earning of net profits and so there is no contractual obligation or risk of legal bankruptcy, However, from the equity shareholders, standpoint, preference shares represent security senior to their interests. Thus, preference share divided represent a prior claim on company’s income.
As reference shares have generally on maturity date, its cost may be computed as:
K0 = D/10
Where D is the stated annual dividend and represents the net produced of preference shares. In other words,
Kp = Obligation Incurred (Fixed Dividend)/Net Proceeds Received
If a company sold a 9% preference share of $100 par value at $110 (110% premium) and incurred the issue expenses of $21 per share, the cost of preference share would be:
Kp = 9%/($110-2)= 9%/108 or 8.33 percent.