Financial Management and Strategic Management · Cost of Capital

Cost of Preference Share Capital (Kp) for CA Intermediate

Updated 4 October 2026 · Fact-checked

Cost of preference share capital (Kp) is the annual return a company must pay preference shareholders on the net amount it raises. For irredeemable shares, Kp = PD ÷ NP. For redeemable shares, use the approximate formula or the IRR of the cash flows. No tax shield applies, because dividend is not tax deductible.

Understand Cost of Preference Share Capital

A company raises money by issuing preference shares. In return, it promises a fixed rate of dividend. Cost of preference capital (Kp) is the rate of return the company must earn on that money so that preference shareholders get what they expect.

The fixed dividend is a payout from profit after tax. It is not an expense. So it does not reduce the company's tax. This is the key difference from debt. In cost of debt you use Kd × (1 − t). In cost of preference capital you use no tax adjustment at all.

There are two types in numericals. Irredeemable shares are never repaid, so the cash flow is just a dividend forever. Redeemable shares are repaid at a fixed date, usually at par or at a premium. Here you must include the repayment in the cost.

The base is the net proceeds, not the face value. If you issue at a discount or pay flotation costs (underwriting, brokerage, issue expenses), the company gets less cash. The same dividend on a smaller base gives a higher cost. Use the issue price less flotation costs.

Dividend is calculated on face value, not issue price. A 10% preference share of ₹100 face value pays ₹10 whether it is issued at ₹95 or ₹105. Many marks are lost by applying the rate to the issue price.

Key rules to remember

Irredeemable preference shares: Kp = PD ÷ NP; PD = annual preference dividend (rate × face value). NP = net proceeds = issue price − flotation cost per share.
Redeemable preference shares (approximate): Kp = [PD + (RV − NP) ÷ n] ÷ [(RV + NP) ÷ 2]; RV = redemption value (including any premium). n = years to redemption. NP = net proceeds. Use when the question does not ask for an exact rate.
Redeemable preference shares (exact, IRR method): NP = Σ [PD ÷ (1 + Kp)^t] for t = 1 to n + RV ÷ (1 + Kp)^n; Find Kp by trial and interpolation between two discount rates. Use when the question asks for the exact or yield-based cost.
Net proceeds: NP = Issue price − discount (if any) − flotation cost; Flotation cost may be given as a percentage of issue price or face value. Read the wording.
Tax treatment: Kp is not adjusted for tax; Preference dividend is paid out of profit after tax. Where a question mentions a dividend distribution tax, follow the data given in the question.

How to solve Cost of Preference Share Capital questions

Use this order for every Kp question. It keeps the dividend, the base and the repayment separate.

1Identify the type: irredeemable or redeemable. Look for words like redeemable, maturity, after n years.
2Compute annual dividend: dividend rate × face value. Never use issue price here.
3Compute net proceeds: issue price − discount − flotation cost. If cost is given as a percentage, state which amount it applies to.
4For redeemable shares, find redemption value: face value plus any premium on redemption, and note the years n.
5Apply the formula: PD ÷ NP for irredeemable, or the approximate formula for redeemable. Use the IRR method only if the question asks for exact or yield cost.
6Do not apply (1 − t). If the question gives any dividend tax, use only the treatment stated in the question and show it clearly.
7Write the answer as a percentage, correct to two decimals, with a one-line comment if the question asks for interpretation.

Quickest way: Four-line Kp method for exam time

When to use it: Use for MCQs and for the first half of a written answer on WACC or capital structure questions where Kp is just one component.

Write PD, NP, RV and n in four lines before any calculation.
For irredeemable shares, divide PD by NP and stop.
For redeemable shares, compute the numerator (PD + (RV − NP) ÷ n) and the denominator ((RV + NP) ÷ 2) separately, then divide.
In MCQs, check the sign of the result. If NP is below face value, Kp must be above the stated dividend rate. If NP is above face value, Kp must be below it. This removes options fast.
In written answers, show each of the four items and the formula with figures. Step marks are given even if the final figure is off.

Common mistakes in Cost of Preference Share Capital

Applying the dividend rate to issue price instead of face value.
Students link the rate to the money received.
Fix: Dividend = rate × face value, always. Issue price only affects the denominator.
Multiplying Kp by (1 − tax rate).
Students copy the debt formula.
Fix: Preference dividend is not tax deductible, so there is no tax shield. Leave Kp unadjusted.
Ignoring flotation cost in the denominator.
Students use face value or issue price as the base.
Fix: Always compute net proceeds first and use that figure.
Leaving out the redemption premium in redeemable shares.
Students take RV as face value by default.
Fix: RV = face value + premium on redemption. Read the redemption terms.
Using the irredeemable formula for redeemable shares.
The two formulas look similar and the first is shorter.
Fix: If the question gives a redemption date, the repayment is a cash flow. Use the redeemable formula.
Mixing up flotation cost percentage bases.
Cost may be stated on face value or on issue price.
Fix: Apply the percentage to the amount named in the question, and write that amount in your working.

Worked examples

Example 1

A company issues 12% irredeemable preference shares of ₹100 face value at ₹95 each. Flotation cost is ₹5 per share. Calculate the cost of preference share capital.

Show the solution

Annual dividend PD = 12% × ₹100 = ₹12.
Net proceeds NP = ₹95 − ₹5 = ₹90.
Kp = PD ÷ NP = 12 ÷ 90.
Kp = 0.1333, which is 13.33%.

Answer: Kp = 13.33%

Example 2

A company issues 10% redeemable preference shares of ₹100 face value at ₹94 per share. Flotation cost is ₹4 per share. The shares will be redeemed at par after 5 years. Calculate the cost of preference capital using the approximate formula.

Show the solution

PD = 10% × ₹100 = ₹10.
NP = ₹94 − ₹4 = ₹90.
RV = ₹100 (redeemed at par), n = 5.
Annual share of gain on redemption = (100 − 90) ÷ 5 = ₹2.
Numerator = 10 + 2 = ₹12.
Denominator = (100 + 90) ÷ 2 = ₹95.
Kp = 12 ÷ 95 = 0.1263, which is 12.63%.

Answer: Kp = 12.63% (approximately)

Exam tips

Kp often appears inside a WACC or capital structure question. Calculate it first and put it in a small table with Kd, Ke and weights.
Read whether flotation cost is a rupee amount or a percentage, and on which base. This is where most data traps sit.
If the question says exact cost or yield, use IRR with two trial rates. Otherwise the approximate formula is expected.
In MCQs, use the discount or premium check: net proceeds below face value means Kp is above the stated dividend rate.
Show PD, NP, RV and n as separate lines in written answers so you earn step marks.

Practice questions from Cost of Capital

Cost of Preference Share Capital in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Cost of Preference Share Capital: frequently asked questions

What is the formula for cost of preference shares?

For irredeemable shares, Kp = PD ÷ NP. For redeemable shares, Kp = [PD + (RV − NP) ÷ n] ÷ [(RV + NP) ÷ 2]. PD is the annual dividend on face value and NP is net proceeds after flotation cost.

What is the difference between cost of debt and cost of preference capital?

Interest on debt is tax deductible, so the cost of debt is adjusted by (1 − t). Preference dividend is paid from profit after tax, so Kp has no tax shield. Debt is also repaid before preference shareholders in a winding up.

Is preference dividend tax adjusted in Kp?

No. The company gets no tax saving on preference dividend, so you do not multiply by (1 − t). If a question gives a specific dividend tax, follow the treatment stated in the question.

When should I use the IRR method for redeemable preference shares?

Use it when the question asks for the exact cost or yield. You find the rate at which the present value of dividends and redemption value equals net proceeds. Otherwise the approximate formula is faster and accepted.