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CA Intermediate · Financial Management and Strategic Management · Cost of Capital

Aarav Textiles Ltd issued 10% preference shares of face value ₹100 each, redeemable at par after 5 years, at a price of ₹100 per share. Flotation costs are ignored. Dividend is paid annually. What is the cost of preference capital (before any tax consideration)?

The cost of preference capital is 10%. The shares are issued and redeemed at par with no flotation cost, so cost equals the annual dividend of ₹10 divided by the ₹100 proceeds. Preference dividend is not tax deductible, so no tax adjustment is made.

  1. A8%
  2. B10%Correct
  3. C12.5%
  4. D9%

Explanation

Issue at par and redemption at par with no flotation cost means Kp = Dividend / Net proceeds = 10/100 = 10%. The pref dividend is not tax-deductible, so no tax adjustment. Option 9% wrongly deducts tax at ~10%, which is not applicable.

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