Cost of redeemable debentures using approximation

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.