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

Meridian Pharma Ltd has issued 12% irredeemable preference shares of face value ₹100 each at par. Flotation cost is ignored. What is the cost of this preference capital (before any tax consideration, since preference dividend is not tax-deductible)?

The cost of the preference capital is 12%. For irredeemable preference shares issued at par with no flotation cost, cost equals the dividend rate, because preference dividend is not tax-deductible and so gives no tax shield.

  1. A8.4%
  2. B12%Correct
  3. C10.8%
  4. D13.2%

Explanation

For irredeemable preference shares, Kp = Dividend / Net proceeds = 12 / 100 = 12%. Preference dividend is paid out of after-tax profit, so no tax adjustment applies. The 8.4% figure wrongly applies a 30% tax shield (12 x 0.70).

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