Valuation of Preference Shares

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Valuation of Preference Shares

Meaning: Preference shares are issued by a joint stock company for raising share capital from the public. It may be redeemable preference shares or irredeemable preference shares.
The value of preference shares also is, generally, determined through the capitalization technique.
The process of determination of the present value of preference share is the same as that of bonds or debentures. The processor determination of the present value of a preference share can be considered under two heads viz.
1. When preference shares is redeemable.
2. When preference shares is irredeemable.

When Preference Share is Redeemable

Present value of a redeemable preference share can be determined by estimating its future cash flows, and then discounting the estimated future cash flows at an appropriate capitalization rate or discount rate.
The estimated future cash flows from the preference share consists of the stream of future dividend payment plus the par value of the preference share.
The following formula may be used to determine the present value of the preference share (assuming that the preference share has a maturity period of 3 years):
( ) ( ) ( )
1 2
1 2 3
p p p
V = D/(1 + K) + D/(1 + K) (1 + K) + {(D+M)/(1 + K) (1 + K) (1 + K)}
Where,
V = Present value of the preference shares.
D = Annual dividend payment.
Kp = Capitalization rate or discount rate.
M = Maturity value i.e., the value of the preference share.
Alternatively, the present value of the preference share can be determined through the table called the present value Tables.

Present Value of Perpetual or an Irredeemable Preference Share

The present value of irredeemable preference share can be determined by simply discounting the streams of dividend payment for the infinite period by an appropriate capitalization rate of the discount rate.
Formula:
V = D/Kp
Where,
V = Present value of the preference share.
D = Annual dividend payment on the preference share.
Kp = Capitalization rate.

Preference Shares