Irredeemable Preference Share & Redeemable Preference Share

Irredeemable Preference Share

The preference share may be treated as a perpetual security if it is irredeemable. Thus, its cost is given by the following equation (for a perpetuity):

kp = DIV+RV-NP/N/RV+NP/2

where kp is the cost of preference share, DIV is the expected preference dividend, Rv is redeemable value,NP is net proceeds now and N is number of years for maturity.

Redeemable Preference Share

Redeemable preference shares (that is, preference shares with finite maturity) are also issued in -practice. A formula similar to above Equation can be used to compute the cost of  redeemable preference share:

K=D/NP  

where D is dividend outflow each year and NP is net proceeds from the issue.

The cost of preference share is not adjusted for taxes because preference dividend is paid after the corporate taxes have been paid. Preference dividends do not save any taxes. Thus, the cost

of preference share is automatically computed on after-tax basis. Since interest is tax deductible and preference dividend is not, the after-tax cost of preference is/ substantially higher than the

after-tax cost of debt