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Good Day. I am a student from south africa and i am currently doing the module MAC3702. I have a question where i need to calculate the cost of capital, and therefore i have to calculate the cost of preference shares given the following information: The 9% preference shares are redeemable at a premium of 5% in 10 years’ time. Dividends for the current year have been paid and the preference shares in a similar risk class are currently yielding 12% per annum. How would i go about calculating the cost of preference shares.
This is not in the syllabus for Paper F3.
Calculating the cost of capital is examined in Paper F9.You would calculate the market value in the same way as for redeemable debt, which is to calculate the present value of the future receipts discounted at the required rate of return.
In this case, for every $100 nominal value, the receipts are dividends of $9 per year for years 1 to 10, and repayment of $105 in 10 years time. You would discount these flows at 12%.
You can find free lectures on the valuation of debt finance (i.e. bonds / loan stock – which is exactly the same approach) in the Paper F9 section of the website, called ‘Valuation of securities’.
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