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Preference Shares | Cost of preference shares Calculation Examples

welcome to contacts in this lesson we're

going to be looking at preference shares

but here we're going to focus on the

calculation of preference shares we're

going to look at how to calculate the

cost of preference shares as well as the

market price of preference shares and

we'll do this with the help of a few

examples you know other lessons we

looked at the preference shares and we

looked specifically at the types of

preference share so we'd like to check

that one out you'll find the link in the

description below

where are our preference shares

preference shares or otherwise known as

preferred stock shares in the equity of

an entity which entitles the holder to a

fixed dividend amount by the issuing

company this dividend must be paid

before the company can issue any

dividends to its ordinary shareholders

now we also looked at ordinary Sheryl

does not other lessons and we looked at

how to calculate the ordinary shares so

you find the link to that lesson as well

in the description below

even entities dissolved the holders of

preference shares are paid back before

the holders of ordinary shares okay and

we've mentioned that above as well

however unlike ordinary shareholders the

holders of preference shares do not

usually have any voting rights over the

affairs of the entity so what we are

seeing here in short is that there is a

difference between ordinary shareholders

and preference shareholders preference

shareholders receive their dividends

first or receive their dues first and

they receive this usually every here

okay ordinary shareholders do not have

to receive it every year and do not have

to receive it at all the bank depending

on whether that company makes money but

it has voting rights which preference

shareholders do not ever result of

preference shareholders ranking higher

in payment priority preference shares

unless the risky and therefore have a

cheaper cost compared to ordinary shares

so you can see from this that preference

shares are usually cheaper than ordinary

shares because ordinary shareholders

take more risks because they get paid

last while preference shareholders get

paid every period ok and they get paid

before the owners all as I'm paid so

they take less risk there is why you

would expect the preference shares to

cost less than they ordinary shares okay

so let's get into the examples how do

you calculate the preference shares well

that two things were going to look at

here how to calculate the cost of

preference shares and want you to get

the formula for calculating the cost of

preference shares and the second one is

how to calculate the market price of

preference shares so what is the cost of

preference shares how do you calculate

it well here's the formula RP obviously

standing for the cost of preference

shares which is a percentage you get it

by taking the dividend or they return to

the preference shoulder divided by the

market price per share so the p0 you're

seeing there is the current market price

or the market price per share so you're

taking the dividend per share divided by

the current market price per share here

we're looking at preference shares we're

not looking at ordinary share so it's

good to bear that in mind okay and we'll

go through examples to apply this

formula here so you do not have to worry

about it and how do we get the market

price of preference shares whereas the

formula for calculating that one well

you can just see here we are just

switching the formula around to get the

market price of the preference shares we

take the dividend so you can see the

numerator does not change and we divide

that by the required return and remember

the required return here written as RP

okay and there is our get the market

price of preference shares so let's get

into the examples and see how we do

these calculations let's look at the

first one we are told that a company has

two million preference shares at 50

Cent's yielding 10% with a market price

currently 55 cents what is the cost of

preference shares so here we are asked

to compute the cost of preference shares

so here I feel elements that you'll

usually be given or you'll usually see

in a question where you ask to calculate

what the preference shares cost is or

what the preference shares market price

is you will be given what it was bought

at or what the par value is so you

usually be given some times like this

where you have pressure and shares at 50

cents yielding 10% okay so this at 50

cents this 50 cents here is the par

value or the amount at which the

preference shares were issued yielding

10%

okay this 10% here is the dividend okay

is not the yield to maturity or this is

not the cost of the preference share

what we want to have fleet here we are

asked the cost of the preference share

okay so this 10% here is the return that

the preference you all will be receiving

annually okay and we are given obviously

the market price and another market

price is the price at which the

preference share is currently trading at

okay so it's 55 cents here so what is

the first thing that we need to - you

need to calculate the rand value or the

value of the dividend that they will be

receiving cause remember in our formula

we starting with the dividend okay the

cost of the preference share is what we

are calculating and we are starting with

the dividend we'll get the numerator so

we take the par value multiplied by the

percentage that we are given okay so we

know that it's preference shares at 50

cents and there is the par value and we

are given the 10 percent we are told

it's filled in 10 percent so there is

the dividend 10 percent and it's 10

percent of what is the percent percent

of market price or 10 percent of issue

price of par value when it's 10 percent

of par value and it will always be 10%

of the par value so what is the dividend

the dividend a is the 10 percent times

the 50 cents okay 10 percent times the

50 cents and you can see it gives us

five cents that is the dividend that the

shareholders will be receiving now that

we have our numerator we have our

denominator as well we remember we say

that the p0 here is the current market

price which is the 55 cents so we're

going to take the five cents dividends

divided by the current market price

which is 55 cents and we will have the

cost of preference shares which in this

case is nine point one percent okay 9.10

person or if you run it down to nine

percent that is as easy as how you

calculate the cost of preference shares

now let's look at more examples in

various ways they matter but they might

ask you how to calculate the cost of

preference shares we are given here that

we are told here that 1 million

preference shares trading at one R and

20 cents per share issued at Turon per

share with 12 percent per annum fixed

rate of interest what is the cost of

preference shares okay what are the cost

so here again we are applying the same

principles we have the formula up here

the cost of preference shares across the

dividend divided

by the current market price what is the

dividend here the dividend is that

percentage we are given and we're told

it's 12 percent per annum fixed rate of

interest so that is the percentage that

given every year as interest okay or as

a dividend and you multiply that based

on the issue price okay how much it was

initially issued at okay and which one

is it you can try and guess if you guess

the one brand 20 you'd be wrong because

one band 20 is the current market price

because we are told here trading at two

hundred twenty cents per share but if

you guessed to Rend you'd be correct

because it was issued at turin so you're

looking at those keywords here

how much doesn't issue dat or what is

the par value so they might choose

poverty they might say it should end so

it was issued at turin per share with a

12 percent fixed rate of interest per

annum okay so we're going to take the

twelve percent that we given times the

issue price of the share which is to

rent and it gives us 24 cents which is

the dividend per share okay so it's a

dividend so we have the numerator what

is the denominator is the current market

price and we are told that it's trading

at 120 so there is the current market

price so it's going to be the 24 cents

divided by the one run 20 current market

price of the preference share and it

gives us 20 percent so the cost of

preference shares is 20 percent you can

see it's actually very high and the

reason it's highest because it was

bought at Turin but now it has fallen

it's now only worth 1 during 20 so it's

worth one when 20 the outlook on the

company obviously is low that means I

want a higher return if I'm investing in

the company that's why it's 20 percent

but you are given okay

I hope it's making sense and I hope

you're following along here's a third

example okay and what I want you to do

here is to pause the video right here

and attempt this question before you

continue the video and see the answer

okay so you can pause right now and try

it okay I hope you post the video and

you try it out so let's take a look a

company is considering issuing a 10%

preference share with a par value of 87

ran the current the share currently

sells for 95 m and the cost of issuing

the share is 5 r n what is the cost of

the preference share okay so now here we

have something new okay so you may have

battle to attempt it we do not know

about

one here we are told here the new thing

that we have here's the cost of issuing

the share is five rent okay this is also

known as the flotation cost or get the

cost of issuing the preference share so

what you do with this one here we have

the numerator which is the dividend

which does not change we can calculate

that easily is the 10% pressure and

share that we are given so it's a 10%

when we have we have the poverty or the

issue price of the preference share

which is 87 grams so we take 10% of 87

bran and it will give us the dividend

which is a trend 70 cents okay I hope

you got that one correct now what do we

do that denominator which is the current

market price well here's how you do it

you take the current market price and

you deduct any issuing hospital that you

incurred okay I will say that again you

take the current market price remember

that's your usual denominator if we do

not have any issuing cost or would not

have any flotation cost we'll just take

the denominator has the current market

price but if you have the issuing cost

and we have told you at the cost of

issuing the shares five rent or we have

to what is called the flotation cost

that's the term they might use then you

just take the current market price minus

that issuing cost and it should give you

your denominator

you see that's what the one that you'll

put here as P zero okay so let's do that

we have our current market price which

is we are told here that share currently

sells for 95 m and the cost of issuing

is five runs so we'll just take the

current market price of 95 and minus the

five R and cost of issuing the share and

here we have the denominator denominator

which is 95 and minus five end and we

have the numerator obviously which you

calculated is the 8r + 70 dividend

divided by the sum of 95 R + -5 m and

then we get an answer of nine point six

seven percent okay now I hope you

followed this one along as well and you

know what to do with flotation cost or

the cost of issuing the share let's look

at another example over here and I hope

you can attempt this one as well before

you continue the video so you can pause

it and try it and then we can continue

along okay I hope you attempted it let's

look at it eight percent preference

shares trading at 30 grand per share

issued at 25 run per share with a

flotation cost of three percent per

share what is the cost of preference

well we have the formula up here we know

that the dividend is the percentage that

we are given okay

multiplied by the par value of the share

how much it was initially issued at so

we are given 8% here and we are told

that it was issued at 25m so 8% times 25

and gives us to Rend as the dividend or

the annual return to preference

shareholders

so we have our numerator or denominator

we're looking here the current market

price and we are told here trading at 30

grand per share so that's how I

denominator but we have floatation cost

of 3% per share okay so what do you do

with this one here same thing we do like

with the previous one the previous Unruh

given the value or the rent amount here

we're given a percentage so we are

applying the same principle here so

you're just going to take the current

market price minus the current market

price times 1 minus that percentage of

floatation cost okay you can either do

that or you can take the current market

price times hundred minus 3% and you get

97 percent okay so you're gonna take the

current market price of 30 rand times

the 97 percent and there is how you get

it okay so the turin is the numerator

dividend per share divided by the 30

rent and then you open bracket 1 minus

0.03 which is the decimal of 30 percent

and we get the answer of 6.8 7% okay I

hope you followed along if you want the

denominator and you're given the

flotation cost as a percentage then you

can take the current market price open

bracket 1 minus 3rd floatation

percentage and then you will multiply

obviously the 2 and then you will get

the denominator okay otherwise you can

take the current market price of the

preference share times 100% minus 3% and

you should get your answer okay six

point eight seven percent okay so that's

very low in practical sense okay if you

are thinking of investing in a company

you see six point eight seven and that's

extremely low but obviously these are

this is just an example that we are

doing okay let's look at the last

example over here we are told that the

company is considering issuing a 10%

preference share with a par value of 850

right the cost of the preference share

is 8.5%

what is the market price per share and

you can see here what's different

between this one and the previous

examples here we are given the cost of

the preference share which is 8.5% we

are asked to calculate the market price

per share okay which we were given in

all the other examples so remember the

second formula I showed you the current

market price per share equals to the

dividend okay that does not change

because the numerator divided by the

required return or the cost of

preference share okay so what is our

dividend when we are given here 10%

preference share with the par value of

850 or here so obviously multiply the

10% times the 850 to get our dividend

and it's 85 rent okay that's the

dividend and what is our denominator

it's obviously the required return would

use the 8.5% cost of preference share so

if we take the 85 ran divided by the

denominator which is 8.5% we get the

current market price of a preference

share of 1,000 rent okay and that is how

you calculate the cost of the preference

share and the market price of a

preference share I hope you followed

along through these examples and I hope

it was clear enough and I hope you have

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