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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.














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