Irredeemable preference shares investopedia forex

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A firm raises capital from different sources to finance a project. Therefore it is necessary to calculate the cost of capital for each source. In order to attract new investors, a firm creates a wide variety of financing instruments or securities, such as debentures, preference shares, equity, etc. While we calculate the cost of capital of a firm, we calculate specific cost of capital of each source of raising funds at first, and then the overall cost of capital is calculated by combining the specific costs into a composite cost.

The specific cost of capital also helps assessing the relative cost of pursuing one line of financing over other. In this article we will discuss the methods of measuring specific cost of various sources of capital. Debt is the external source of financing. Cost of debt is simply the interest paid by the firm on debt. Again, debt may be redeemable or irredeemable.

Irredeemable debt is that debt which is not required to be repaid during the lifetime of the company. Such debt carries a coupon rate of interest. This coupon rate of interest represents the before tax cost of debt. After tax cost of perpetual debt can be calculated by adjusting the corporate tax with the before tax cost of capital.

The debt may be issued at par, at discount or at premium. The cost of debt is the yield on debt adjusted by tax rate. Sometimes a firm incurs floatation costs such as brokerage, commissions, and legal and accounting fees. These costs are to be subtracted to arrive at the net proceeds.

Another important point to be noted here is that interest and net proceeds must represent same relationship, i. I is taken for the whole of the debentures issued the net proceeds NP of the debt must be of the whole of debentures. Like debt, preference share is of two types as well: Redeemable and irredeemable. But dividend payable on preference shares is not a tax-deductible expenditure.

Hence no adjustment for corporate tax is required for computing the cost of preference shares. It is to be noted here that there is no such obligation in regard to preference shares as we find in case of debt. The holders of preference shares only get preferential right as regards payment of dividend as well as return of principal, compared to equity shareholders. Irredeemable preference share is not required to be repaid during the lifetime of the company. Such preference shares carry a rate of dividend, which is the cost of irredeemable preference shares. Since the shares may be issued at par, at premium or at a discount, the cost of preference shares is the yield on preference shares. Net proceeds from issue of preference shares.