A company issued 10% Preference shares of the face value of Rs 10,00,000 the floatation cost being 5%

Solution :-

Cost of Preference Shares ( after tax) is as follows:-

Kp = D + ((RA-NP)/n)/(RA+NP)/2

Kp = 1,00,000 + ((12,00,000-9,50,000)/5)/ 10,75,000

= 1,50,000/10,75,000 = 13.95%

Note :- Dividend tax payable is not a tax deductible amount as such it is not taken into consideration for calculation.However student can find pre tax Kp as follows:-

Pre tax Kp = Post tax Kp/(1-tax rate) = 13.95%/(1-.15) = 16.41%.

Working notes:-

Flotation Cost = 10,00,000×5% = 50,000

Net proceeds (NP) = 10,00,000-50,000 = 9,50,000

Dividend (D)= 10,00,000× 10% = 1,00,000 as it is paid on face value.

Redemption Premium = 10,00,000×20% = 2,00,000

Redemptiom Amount (RA) = 10,00,000+ 2,00,000 = 12,00,000( In short it is 10 lacs×1.2)

(RA + NP) /2 = (12,00,000+ 9,50,000)/2 = 10,75,000

n = no. Of years.