Cost of Debt Capital

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 retum (or cost) of newly-issued debt is often referred to as the rate. It usually differs from the average cost of the financial capital raised by a firm in the post. Red Oyster Seafood Company is considering issuing a new twenty-five-year debt issue that would pay an annual coupon payment of \$90. 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. Red Oyster's CFO has pointed out that the firm will incur a fotation cost of 2% when initially issulng the bond issue. Remember, these fotation costs Will be from the proceeds the firm will receive after issuing its new bonds. The firm's marginal federal-plus-state tax rate is 35%. To see the effect of fotation costs on Red Oyster's after-tax cost of debt, calculate the before-tax and after-tax costs of the firm's debt issue with and without its fotation costs, and insert the correct costs into the boxes. (Hint: Round your answer to two decimal places.)