Preference Shares are issued by corporations or companies with the primary aim of generating funds.
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A preference share usually carries a fixed stated rate of dividend. The dividend is payable only upon availability of profits.
In case of cumulative preference shares, arrears of dividends can be accumulated and in the year of profits common stock holders can be paid dividend only upon settlement of all the arrears of cumulative preference dividends.
Preference share holders have preference right over payment of dividend and settlement of principal amount upon liquidation, over common share holders. A preference share can be irredeemable or redeemable.
Redeemable preference shares have a fixed maturity date and irredeemable preference shares have perpetual life with only dividend payments periodically upon profit availability.
Preference shares can also be cumulative and non-cumulative.
Valuation of Preference Shares
Basically, the value of a redeemable preference share is the present value of all the future expected dividend payments and the maturity value, discounted at the required return on preference shares.
Redeemable Preference share value
Dividend 1 to n = Dividends in periods 1 to n.
How to Evaluate an Initial Public Offering (IPO)
The shares are redeemable after 5 years period. Calculate the value of preference shares if the required rate of return is 13%.
Annual dividend = $500 x 12% = $60
Redeemable Preference share value =
Solving for the above equation, we get the value of the preference shares as $482 (rounded).
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