Preference
Share Valuation
Preference share offered a
constant return on the investment. Preference share valuation can be determined
by the following formula. The formula is basically perpetuity i.e. present
value of indefinite future dividend.
Preference
Share Valuation Formula
Share price = Dividend / Cost of Capital
Preference
Share Valuation Example
ABC Company offered a
dividend of $ 5 on the preference share. Cost of capital is 6%. Another company
offer same dividend with a cost of capital of 8% .Calculate the share prices
for both companies.
Solution
|
Dividend
|
$ 5
|
$ 5
|
|
Cost
of capital
|
6%
|
8%
|
|
Share
price = Dividend/Cost of Capital
|
83.33
|
62.5
|
=
$5/6%
=
$ 5/.06
= $ 83.33
=
$5/8%
=
$ 5/.08
=
$ 62.5
Above example indicates
that cost of capital and share price has inverse relationship, it means that
high cost of capital will lower the share price and therefore companies try to
keep the cost of capital as low as possible to boost share prices.
