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

Meridian Ltd has 12% preference shares of face value Rs 100, redeemable at par after 10 years, issued at par with no issue costs. Ignoring dividend tax, what is the cost of preference capital (kp) using the simple approximation method?

The cost of preference capital is 12%. Shares are issued and redeemed at par, so there is no discount or premium to amortise, and preference dividend is not tax-deductible. The cost therefore equals the dividend rate on the Rs 100 face value, which is 12%.

  1. A10.00%
  2. B12.00%Correct
  3. C13.20%
  4. D8.40%

Explanation

Kp = [D + (RV - NP)/n] / [(RV + NP)/2] = [12 + (100-100)/10] / [(100+100)/2] = 12/100 = 12%. Because issue and redemption are both at par, there is no gain or loss to spread. 8.40% wrongly applies a 30% tax shield, but preference dividends are not tax-deductible.

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