Cost of Redeemable Debentures (using approximation method) The cost of redeemable debentures will be calculated as below: Cost of redeemable Debenture ( K d ) = I (1-t) + (RV-NP) / n RV+NP 2 Where, I = Interest payment
NP = Net proceeds from debentures in case of new issue of deb or Current market price in case of existing debt.
(As reduced by the flotation cost) RV Redemption value of debentures t Tax rate applicable to the company N Life of debentures. Preference Share Capital - The preference shareholders are paid dividend at a fixed rate on the face value of preference shares. - Payment of dividend to the preference shareholders is given priority over the equity shareholder. - The payment of dividend to the preference shareholders is considered as appropriation of profit and thus it is not a tax-deductible expense. - Like the debentures, Preference share capital can be categorized as redeemable and irredeemable. Cost of Redeemable Preference Shares Preference shares issued by a company which are redeemed on its maturity is called redeemable preference shares. Cost of redeemable preference share is similar to the cost of redeemable debentures with the exception that the dividends paid to the preference shareholders are not tax deductible. Cost of preference capital is calculated as follows: PD (1+Dt)+ (RV-NP) Cost of Reedemable Preference Share (Kp ) = N . RV+NP Where PD = Annual preference dividend RV = Redemption value of preference shares NP = Net proceeds on issue of preference shares (As reduced by the flotation cost) N = Life of preference shares Cost of Irredeemable Preference Shares
The cost of irredeemable preference shares is similar to calculation of perpetuity. The cost is calculated by dividing the preference dividend with the current market price or net proceeds from the issue. The cost of irredeemable preference share is as below: Cost of Irredeemable Preference Share (K ) = PD (1+Dt) / P 0 Where, PD = Annual preference dividend P 0 = Net proceeds in issue of preference shares Equity Share Capital - It is important source of Own funds, which once issued will be there till the buy-back or dissolution of the Company. - The dividend is not paid at a fixed rate but it is declared every year based on the earnings of the Company. - Equity shareholders are given the last priority while making Payment of dividend, The Equity shareholders get dividend when all other parties are paid off. - The payment of dividend to the equity shareholders is considered as appropriation of profit and thus it is not a tax-deductible expense. COST OF EQUITY SHARE CAPITAL It may prima facie appear that equity capital does not carry any cost. But this is not true. The market share price is a function of return that equity shareholders expect and get. If the company does not meet their requirements, it will have an adverse effect on the market share price. Also, it is relatively the highest cost of capital. Due to relative higher risk, equity shareholders expect higher return hence, the cost of capital is also high.
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