CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Meera Textiles issues 9% irredeemable preference shares of Rs 100 face value at par. Flotation cost is Rs 10 per share, so net proceeds are Rs 90 per share. What is the cost of this preference capital?
The cost is 10%. For irredeemable preference shares, cost equals the annual dividend divided by net proceeds. The dividend is Rs 9 and net proceeds after flotation cost are Rs 90, so 9/90 gives 10%. Using face value would ignore flotation cost and give 9%.
- A8.18%
- B9.00%
- C10.00%Correct
- D11.11%
Explanation
Cost of irredeemable preference capital = annual dividend / net proceeds = 9 / 90 = 10%. Using Rs 100 (ignoring flotation cost) gives 9%, which understates the cost. Adding flotation cost to the price (9/110 = 8.18%) is also wrong.
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