4.4 In the case of debt issued at a premium, there will be a difference between the
face value and the book value of such securities. In such cases the cost of debt
will not be equal to the coupon rate of interest. If the premium is amortized for
tax, it should be considered for determining the cost.
4.5 In case of perpetual debt financing, old bonds due for payment will be replaced by
new bonds of the same value. In such a case the cost of capital will be determined
by dividing the price at which the bond is sold multiplied by the fixed interest
charges adjusted after tax-effect.
4.6 The current market yield of the debt will be used as cost of the capital, when debt
is not used.
4.7 Only in case of profits earned, can dividends be paid to the shareholders. If the
dividends are not paid up to the reasonable expectation level of the shareholders,
the credibility of a firm may come down and shareholders may exercise their
voting rights to change the management.
4.8 The dividends are payable in priority to preference shareholders and only the left
out dividends are payable to ordinary share holders.
4.9 If the dividends are not paid, the market price of the shares will come down.
Therefore, the firms always try to maintain the minimum credibility level of
dividend payment.
4.10 The preference share is of two types:
- Irredeemable
- Redeemable
4.11 The first one is treated as perpetual securities.
4.12 The amount payable on maturity date, in case of redeemable preference shares
may be considered to determine the cost of capital. Dividends cannot be deducted
to compute Tax. Therefore the cost of preference shares will be more than the
cost of debt capital.
4.13 The equity holders invest with an expectation of returns in the form of dividends.
The market value of shares of a company depends on the expectations of the
dividends by equity holders.
4.14 The rate of return that equates the PV of the expected dividends with the market
value of shares can be taken as cost of equity capital.