Question

Calculate the cost of preference capital (k_p) for a non-redeemable preference share which has the following:

Price = $16 and a Preference dividend of $1.4 paid every six months. Your answer should the effective annual cost as a decimal accurate to four decimal places. For example an answer of 12.113% should be entered as .1211 with no % sign.

Answer 1

Price of Preference capital = $16

Semi-annual Preference Dividend = $1.4

Calculating the Semi-annual cost of preference capital (k_p):-

Semi-annual cost of preference capital = Semi-annual Preference Dividend/Price of Preference capital

= $1.4/$16

Semi-annual cost of preference capital = 0.0875

Now, Calculating Effective annual cost of preference capital using EAR method:-

Where,

r = Semi-annual cost of preference capital = 0.0875

m = no of times compounding in a year = 2 (compounded semi-annually)

EAR = 1.1827 - 1

EAR = 0.1827

So, the effective annual cost of preference capital (k_p) is 0.1827

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