CA Intermediate · Financial Management and Strategic Management · Cost of Capital
Meridian Textiles Ltd issues 10% irredeemable preference shares of face value ₹100 at par. Flotation cost is 5% of the issue price. Ignoring dividend distribution tax, what is the cost of preference capital (to the nearest 0.01%)?
The cost is 10.53%. The preference dividend is ₹10 per share, while the company actually receives only ₹95 after a 5% flotation cost. Dividing 10 by 95 gives 10.53%. Using the full face value of ₹100 would understate the cost at 10%.
- A10.00%
- B10.53%Correct
- C9.50%
- D5.00%
Explanation
Net proceeds = 100 - 5 = ₹95. Annual dividend = ₹10. Cost = 10/95 = 10.526%, i.e. 10.53%. Option 10.00% ignores the flotation cost; 9.50% wrongly multiplies the dividend rate by (1 - 0.05) instead of dividing by net proceeds.
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