## Cost of Preference Share Capital (Kp)
Preference shareholders receive dividend at a specified rate on face value.
Key tax point: Preference dividend is not an expense — it is an appropriation of after-tax profit. So, unlike debenture interest, it does not reduce the company's tax liability. (Hence there is no (1 − t) factor in Kp.)
Like debentures, preference capital is either irredeemable or redeemable.
### A. Cost of Irredeemable Preference Shares
These are never redeemed by the issuer. Dividend is a perpetuity:
$$K_p = \frac{PD}{P_0}$$
- PD = Annual preference dividend
- P₀ = Net proceeds from issue
### B. Cost of Redeemable Preference Shares
Two approaches — use either when the question is silent.
Relevant cash flows:
| Year | Cash flow |
|---|---|
| 0 | Net proceeds (new issue) / Current market price (existing) — NP or P₀ |
| 1 to n | Preference Dividend (PD) |
| n | Redemption Value (RV) |
(i) YTM Method (PV / IRR Method) — the accurate method.
1. Identify the cash flows.
2. Compute NPVs at two guessed discount rates.
3. Interpolate to find the IRR = Kp.
(ii) Approximation Method (Shortcut/Formula) — gives only an approximate value.
$$K_p = \frac{PD + \dfrac{(RV - NP)}{n}}{\dfrac{(RV + NP)}{2}}$$
where PD = annual preference dividend, RV = redemption value, NP = net proceeds, n = remaining life.