Corporate Accounting and Financial Management · Cost of Capital

Cost of Preference Share Capital: Formula and Numericals

Updated 11 October 2026 · Fact-checked

Cost of preference share capital is the annual return a company must pay preference shareholders, expressed as a percentage of the net money it receives. For irredeemable shares use Kp = D ÷ NP. For redeemable shares use Kp = [D + (RV − NP) ÷ n] ÷ [(RV + NP) ÷ 2]. No tax adjustment is made.

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 share capital is the percentage the company must earn on that money just to keep preference shareholders satisfied.

The cost is worked out on what the company actually receives, not on the face value. If shares of ₹100 are issued at a discount, or flotation costs are paid, the company gets less than ₹100. The same dividend is then paid on a smaller amount, so the cost rises. If shares are issued at a premium, the cost falls.

There are two cases. Irredeemable preference shares are never repaid, so only the dividend matters. Redeemable preference shares are repaid after a fixed period, so the cost must also include the gain or loss at redemption, spread over the years.

Preference dividend is paid out of profit after tax. It is not a deductible expense like interest. So there is no tax shield, and you do not multiply by (1 − t). This is the main difference from the cost of debt. Dividend distribution tax no longer applies to domestic companies, so in exam problems treat the dividend as paid without any company-level tax adjustment unless the question gives a specific tax on dividend. If the question gives one, state your assumption and follow it.

Key rules to remember

Cost of irredeemable preference shares: Kp = D ÷ NP; D = annual preference dividend (rate × face value). NP = net proceeds per share after premium, discount and issue costs.
Net proceeds per share: NP = Issue price − Issue costs (add premium, deduct discount); Use the amount actually received. Issue costs are the flotation costs such as underwriting commission and brokerage.
Cost of redeemable preference shares (approximate): Kp = [D + (RV − NP) ÷ n] ÷ [(RV + NP) ÷ 2]; RV = redemption value, n = years to redemption. The denominator is the average of RV and NP.
Cost of redeemable preference shares (exact): NP = Σ D ÷ (1 + Kp)^t + RV ÷ (1 + Kp)^n; Solve by trial and error or interpolation. It is the IRR of the cash flows.
Tax treatment: Kp is not adjusted for tax; Preference dividend is an appropriation of profit, so no (1 − t) factor.

How to solve Cost of Preference Share Capital questions

Follow the same order for every question so that you do not miss an adjustment.

1Read whether the shares are redeemable or irredeemable. Note the redemption period and redemption value if given.
2Compute the annual dividend: dividend rate × face value per share (or in total).
3Compute net proceeds: issue price, plus premium or minus discount, minus issue costs. Use per-share or total figures, but be consistent.
4Find redemption value. If the shares are redeemed at a premium, RV = face value + premium. Otherwise RV = face value.
5Apply Kp = D ÷ NP for irredeemable shares, or the redeemable formula with the average in the denominator.
6Do not apply any tax adjustment. Write one line saying preference dividend is not tax deductible.
7Convert to a percentage and round as asked. Show the formula, the substitution and the final answer.
8 If the question asks for the exact cost, test two discount rates and interpolate.

Quickest way: Three-number shortcut

When to use it: Use this for redeemable preference shares when the question asks for the cost without asking for the exact IRR.

Write D, NP, RV and n in a small box.
Compute the yearly gain or loss: (RV − NP) ÷ n.
Add it to D for the numerator.
Compute (RV + NP) ÷ 2 for the denominator.
Divide and convert to percent. For irredeemable shares, just do D ÷ NP.

Common mistakes in Cost of Preference Share Capital

Using face value instead of net proceeds in the denominator.
The dividend rate is given on face value, so students divide by face value too.
Fix: Always compute NP first. The dividend uses face value, the denominator uses what the company receives.
Adjusting the cost for tax as if it were debt.
Students memorise Kd = I(1 − t) and copy the pattern.
Fix: Remember that preference dividend is paid from after-tax profit. No (1 − t) factor.
Forgetting issue costs when finding net proceeds.
Issue costs are hidden in the last line of the question.
Fix: Underline every cost and premium or discount before you start, and subtract costs from the issue price.
Using only D ÷ NP for redeemable shares.
Students learn the irredeemable formula first and apply it everywhere.
Fix: If there is a redemption date, add (RV − NP) ÷ n to the numerator and use the average in the denominator.
Taking RV as face value when redemption is at a premium.
Students overlook the redemption premium clause.
Fix: Read the redemption terms separately. RV = face value + redemption premium.

Worked examples

Example 1

Reliance Textiles Ltd issues 10% irredeemable preference shares of ₹100 each at ₹95. Issue costs are ₹5 per share. Find the cost of preference share capital.

Show the solution

Annual dividend D = 10% × ₹100 = ₹10.
Net proceeds NP = ₹95 − ₹5 = ₹90.
Irredeemable, so Kp = D ÷ NP = 10 ÷ 90.
10 ÷ 90 = 0.1111, which is 11.11%.
No tax adjustment is made.

Answer: Cost of preference share capital = 11.11% (approximately).

Example 2

Bharat Foods Ltd issues 12% redeemable preference shares of ₹100 each at par. Issue costs are ₹4 per share. Shares are redeemable after 5 years at a premium of 5%. Find the cost using the approximate formula.

Show the solution

D = 12% × ₹100 = ₹12.
NP = ₹100 − ₹4 = ₹96.
RV = ₹100 + 5% of ₹100 = ₹105.
n = 5 years.
Yearly adjustment = (105 − 96) ÷ 5 = 9 ÷ 5 = ₹1.80.
Numerator = 12 + 1.80 = ₹13.80.
Denominator = (105 + 96) ÷ 2 = 201 ÷ 2 = ₹100.50.
Kp = 13.80 ÷ 100.50 = 0.13731, about 13.73%.

Answer: Cost of redeemable preference share capital = 13.73% (approximately).

Exam tips

Show the formula, then the substitution, then the answer. Marks are given for method even if arithmetic slips.
State your assumption in one line when the question mentions dividend tax or is silent on it.
Scan the question for premium, discount, issue costs and redemption premium before you calculate.
Keep working in per-share figures unless totals are given, to reduce arithmetic errors.
Practise the comparison with cost of debt, because a short theory question often asks why Kp has no tax shield.

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 share capital?

For irredeemable shares, Kp = D ÷ NP. For redeemable shares, Kp = [D + (RV − NP) ÷ n] ÷ [(RV + NP) ÷ 2]. D is the annual dividend and NP is the net proceeds.

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

Interest on debt is tax deductible, so cost of debt is Kd = I(1 − t) on the relevant base. Preference dividend is paid from profit after tax, so there is no tax saving. Also, debt is a legal obligation, while preference dividend is paid only out of profits.

Do I deduct tax when calculating cost of preference shares?

No. Preference dividend is not an expense that reduces taxable profit, so you do not multiply by (1 − t). If a question gives a specific tax on dividend, state your assumption and follow the question.

How do I calculate the cost of redeemable preference shares?

Find D, NP, RV and n. Add the yearly gain or loss at redemption to D, and divide by the average of RV and NP. For exact cost, find the rate at which the present value of dividends and redemption equals NP.