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CS Executive · Corporate Accounting and Financial Management · Cost of Capital

Which statement correctly describes the treatment of preference dividend when computing the cost of preference share capital in India?

Preference dividend is paid from profits after tax and is not an expense for tax purposes, so it creates no tax shield. The cost of preference capital is therefore computed without any tax adjustment, unlike the cost of debt, where interest is deductible.

  1. APreference dividend is tax-deductible, so cost is computed after adjusting for tax
  2. BPreference dividend is paid out of profit after tax, so no tax adjustment is made to its costCorrect
  3. CCost of preference capital is always lower than cost of debentures
  4. DCost of preference capital equals the coupon rate of debentures

Explanation

Preference dividend is an appropriation of profit after tax and gives no tax shield. Hence the cost is not multiplied by (1 - tax rate). Option 1 wrongly gives a tax shield, which applies only to interest on debt.

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