Page 308 - Corporate Finance PDF Final new link

NPP

308 Corporate Finance BRILLIANT’S

Solution:
(i) Debt issued at par
15,000
Before tax cost, K = 1,00,000  15%
i
After tax cost, K = K (1- t) = 15% (1 – 0.5) = 7.5%
d i
(ii) Issued at 10% discount
15,000
Before tax cost, K =  16.7% approx. 
d 90,000
After tax cost, cost, K = 16.7% (1 – 0.5) = 8.3%
d
(iii) Issued at 10% premium
15,000
Before tax cost, K =  13.6%
d 1,10,000
After tax cost, K = 13.6% (1 – 0.5) = 6.8% (appox.)
d
Cost of Preference Share (K ) H$m°ñQ> Am°’$ {à’$a|g eo¶a (K )
P P
The cost of preference share is represented H$m°ñQ> Am°’$ {à’$a|g eo¶a H$mo Eogo {’$³ñS> {S>{dS>oÝS>
by a fixed dividend payment carrying a higher no‘|Q> Ûmam àñVwV {H$¶m OmVm h¡ Omo Bp³dQ>r eo¶a {S>{dS>oÝS>g
order of precedence than equity share H$s VwbZm ‘| {à{gS>oÝg H$m hm¶a Am°S>©a aIVm h¡& Bg‘|
dividends. It does not have the binding
S>oãQ> Am°’$ BÝQ>aoñQ> H$s Vah H$moB© H$m°ÝQ´>o³MwAb Am°pãbJoeZ
contractual obligation as of interest on debt. Zht ahVm h¡& EH$ hmB[~«S> {g³¶y[aQ>r Ho$ ê$n ‘| {à’$a|g
Preference share, being a hybrid security, has
neither the ownership privilege of equity nor eo¶a ‘| Z Vmo Bp³dQ>r H$m AmoZa{en {à{dboO ({deofm{YH$ma)
the legally enforceable provisions of debt. The hmoVm h¡ Am¡a Z hr S>oãQ> H$mo {d{YH$ ê$n go àd{V©V H$am¶m
cost of preference share is found by dividing Om gH$Vm h¡& {à’$a|g eo¶a H$s H$m°ñQ> kmV H$aZo Ho$ {bE
the annual preference share dividends by net EݶyAb {à’$aoÝg eo¶a {S>{dS>oÝS>²g ‘| {à’$a|g eo¶a H$s
proceeds from the sale of preference share. The gob go àmßV ewÕ YZam{e H$m ^mJ {X¶m OmVm h¡& ewÕ
net proceeds represent the amount of money YZam{e kmV H$aZo Ho$ {bE àmßV YZam{e ‘| go H$m°ñQ> H$mo
to be received minus cost. KQ>m¶m OmVm h¡&

D p
K p 
NP
Where, K = the cost of preference share,
p
D = the preference share dividend
p
NP = Net market price after adjusting premium discount and floatation cost.
For example,
(i) If D = ` 20; NP = ` 100 then;
p
20
K   20%
p
100