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.

Consider the case of Red Oyster Seafood Company:

Red Oyster Seafood Company can issue a 25-year debt security that pays an annual coupon payment of $90. The bond carries a par value of $1,000 and is currently trading at par. Based on this information, determine the after-tax cost of Red Oysters debt if the firms marginal federal-plus-state tax rate is 35%.

1) Red Oyster Seafood Companys after-tax cost of debt (rounded to four decimal places) is:

5.5575%

4.9725%

5.8500%

6.4350%

2) Red Oysters CFO has pointed out that if these new bonds are issued, the company will incur a flotation cost of 2%. Remember, these flotation costs will be ________ (added or subtracted) from the proceeds the firm receives from the sale of its new bonds. Calculate the companys after-tax cost of debt net of the issues flotation costs.

3) If Red Oyster issues its new bonds and incurs flotation costs of 2%, then its adjusted (net) after-tax cost of debt (rounded to four decimal places) will be:

5.9846%

7.0200%

6.4350%

5.5575%