3. The cost of debt capital Aa Aa The cost of debt that is relevant when companies are evaluating new investment projects is the marginal cost of the new debt that is to be raised to finance the new project The required return (or cost) of newly-issued debt is often referred to as the from the average cost of the financial capital raised by a firm in the past. rate. It usually differs Consider the case of Purple Lemon Fruit Company: Purple Lemon Fruit Company is considering issuing a new fifteen-year debt issue that would pay an annual coupon payment of $75. Each bond in the issue would carry a $1,000 par value and would be expected to be sold for a market price equal to its par value. Purple Lemon's CFO has pointed out that the firm will incur a flotation cost of 2% when initially issuing the bond issue. Remember, these flotation costs will be new bonds. The firm's marginal federal-plus-state tax rate is 40% from the proceeds the firm will receive after issuing its To see the effect of flotation costs on Purple Lemon's after-tax cost of debt, calculate the before-tax and after-tax costs of the firm's debt issue with and without its flotation costs, and insert the correct costs into the boxes. Before-tax cost of debt without flotation cost: After-tax cost of debt without flotation cost: After-tax cost of debt with flotation cost: After-tax cost of debt with flotation cost