Skip to main content

What is Preference Share Capital? How to calculate Preferred Dividend Coverage ratio and Earnings per Preference Share?


Preference Share Capital: Those shares which do not provide voting right in a company but give fixed dividend and at the time of liquidation the holder of these shares get their fixed dividend before equity share holders is called preference Share Capital.

Types of Preference Share Capital:

Convertible Preference Share
A share which converts from preference shares to equity.
Non-Convertible Preference Share
A share doesn’t have a quality of conversion from preference shares to equity.
Cumulative Preference Share
The holders have a right to get any previous arrears dividend with current dividend if company has enough profit.
Non-Cumulative Preference Share
The holders don’t have a right to get any arrears dividend with current dividend.
Participating Preference Share
The shareholders have a right to participate in surplus profit after paid to ordinary share holders.
Redeemable Preference Share
The shares which are redeemable in future.
Irredeemable Preference Share
The shares which are not redeemable in future or doesn’t mature in future. It matures only when Company is winding up.

Preferred Dividend Coverage ratio: It shows the ability of a company to pay the dividend to its preference shareholders. The higher ratio means company is able to pay dividend to preference shareholders if not company having some difficulty to pay dividend to its preference shareholders. It is also known as Times Preferred Dividends Earned.

Formula:
Net income / Total preferred dividends
Where,
Net income = Earnings after tax

Earning Per Preference Share:
It shows how much return each shareholders earn by investing in a company’s preference share. If the ratio is high it shows better condition of company to pay its dividend to shareholders easily.

Formula:
 Net income / Number of Outstanding preference shares

Example: Company X has authorized capital of Rs. 25, 00,000 and it decided to issue debt , equity and preference share. Find out the earnings per preference share with the help of following information:
1)      Issued Capital Rs.20, 00,000:
5,000 Preference share @ 7% of Rs.100 each.
1, 00,000 equity of Rs.10 each.
5,000 debenture @ 10% of Rs.100 each.
2)      Earnings before interest and tax = Rs.12,42,000
3)      Tax @30%

Solution:
Particulars
Amount
Earnings before interest and tax (EBIT)
12,42,000
Less: Interest
50,000
Earnings before tax
11,92,000
Less: tax
3,57,600
Earnings after tax
8,34,400
Less: Preference Share Dividend
35,000
Earnings available for shareholders
7,99,400

Earning per Preference Share = Net income or Earnings after tax / Number of Outstanding preference shares
= 8, 34,400 / 5000
= Rs. 166.88

Example: In Jan 2008 Company Y issues 60,000 preference share @ 8% of Rs.10 each and 20,000 equity shares of Rs.10 each. In august 2010 company suffers a loss due to lack of new technology. The market share of company goes down. In March 2011 Company’s net earnings are Rs.6, 00,000. Find out how can preference shareholders know the company’s able to pay their dividend. (With the help of any ratio)

Solution: Preference shareholders can know the company’s dividend paying capability with the help of Preferred Dividend Coverage ratio.
Preferred Dividend Coverage ratio = Net income / Total preferred dividends
= 6, 00,000 / 48,000
= 12.5
Interpretation: The ratio 12.5 shows that company’s available earnings are enough to pay preference shareholders dividend.

Example: Find out the Times preferred dividend earned with the help of following information:
·         Earnings after Interest tax = Rs.10,52,600
·         Outstanding Preference shares = Rs. 8,00,000 @ 7% of Rs. 100 each
·         Tax @40%
·         70,000 Equity shares of Rs.10 each
·         Paid- up preference share capital =Rs. 20,000

Solution:
Times preferred dividend earned / Preferred Dividend Coverage ratio = Net income / Total preferred dividends
= 10, 52,600 / 56,000
= 18.79
Interpretation: The ratio 18.79 shows that company is able to pay dividend to preference shareholders easily.

Example: Company Y issues 20,000 preference shares @ 9% of Rs.50 each. Company’s current year and past four years net earnings are as follows:
·         2012: Rs.8,98,000
·         2013: Rs. 12,25,680
·         2014: Rs. 26,46,500
·         2015: Rs. 10,95,620
·         Current year : Rs. 27,52,990
      How investors can decide to invest in Y Company’s preference share.

Solution:
Investors can take investment decision with the help of these ratios:
·         Preferred Dividend Coverage ratio = Net income / Total preferred dividends
= 27, 52,990 / 90,000
=30.58
Higher the ratio means safer for the preference shareholders to get their dividend.

·         Earning per Preference Share = Net income or Earnings after tax / Number of Outstanding preference shares
=27, 52,990 / 20,000
=Rs. 137.64
Higher the ratio means safer for the preference shareholders to get their dividend.

Note: These two ratios only provide information of how much company’s earnings are enough to pay dividend to preference shareholders. It doesn’t give information of any cash availability in Company.














Comments

Post a Comment

Popular posts from this blog

How to calculate Cost of Preference Share Capital?

Cost of Preference Share Capital:  An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital. Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt. Formula for Cost of Preference Share: Irredeemable Preference Share Redeemable Preference Share K p  = Dp/NP K p  = D p +((RV-NP)/n )/ (RV+NP)/2 Where, K p  = Cost of Preference Share D p  = Dividend on preference share NP = Net proceeds from issue of preference share (Issue price – Flotation cost) RV = Redemption Value N = Period of preference share Example:  A company issues 20,000 irredeemable preference share at 8% whose face value is Rs.50 each at 4% discount. Find out the Cost of ...
88 comments
Read more

What is the difference between Cheque book and Pass book?

 Cheque book is issued by bank in customers / account holder request. With the help of this book account holder can withdraw cash from his/her account. Bank does not charge any fee to issued cheque book to its customer. But afterward bank charges some amount for using bank facility like cheque book, Debit card etc.So, Automatic some definite amount deducted from customer bank account. Pass book is  also issued by bank to its customer. It helps to record all the bank related activity according to date that is withdrawal and deposit. It is recorded by bank but the book is kept by customer to know the current balance of  his /her account.  Point of difference Pass book Cheque book What is the meaning of pass book and cheque book? Passbook is a book in which all withdrawal and deposit against customer account is recorded.   Cheque book is a book of cheques which are used to withdrawal the money to b...
Post a Comment
Read more

Numericals with solutions of Net income Approach

Net income approach questions and answers:   Questions:  Find out the value of the firm with the help of given information: Particulars Amount Earnings before interest and tax 3, 50, 000 Cost of equity 10% Cost of debt 7.2% Debenture 1,00,000 Find out the overall cost of capital with the help of net income approach. (Assume tax rate-10%) Solution: Particulars Amount Earnings before interest and tax 3, 50, 000 Less: Interest @7.2% 7, 200 Earnings before tax 3, 42, 800 Less: Tax@10% 34, 280 Net income 3, 08, 520 Cost of equity 10% Market value of equity (S =net income/ cost of equity) 30, 85, 200 Market value of debt (B) 1, 00, 000 Value of the firm (S+B) 31, 85, 200 Questions:  Find out the overall cost of capital if the equity capitalisation rate is 12...
1 comment
Read more