Question

**3. The 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 return (or cost) of previously issued debt is often referred to as the rate. It usually differs from the cost of newly raised financial capital.

Consider the case of Cold Duck Brewing Company:

Cold Duck Brewing Company is considering issuing a new twenty-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.

Cold Duck’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 from the proceeds the firm will receive after issuing its new bonds. The firm’s marginal federal-plus-state tax rate is 45%.

To see the effect of flotation costs on Cold Duck’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. (Note: Round your answer to two decimal places.)

Before-tax cost of debt without flotation cost: | % |

After-tax cost of debt without flotation cost: | % |

Before-tax cost of debt with flotation cost: | % |

After-tax cost of debt with flotation cost: | % |

Answer #1

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3. The cost of debt
What do lenders require, and what kind of debt costs the
company?
The cost of debt that is relevant when companies are evaluating
new investment projects is the marginal cost of the new debt to be
raised to finance the new project.
Consider the case of Red Oyster Seafood Company (Red
Oyster):
Red Oyster Seafood Company is considering issuing a new 20-year
debt issue that would pay an annual coupon payment of $70. Each
bond...

Sample company is considering issuing a new 20 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 price equal to it par value.
Sample point out that the firm would incur a floatation cost of
2% when initially issuing the bond issue. Remember, the flotation
cost will be --------- (subtracted or added) from the proceeds the
firm...

(Cost of debt) Sincere Stationery Corporation needs to raise
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issue a
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and a maturity of 18 years. The investors require a rate of return
of 14 percent.
a. Compute the market value of the bonds.
b. What will the net price be if flotation costs are 11 percent
of the market price?
c. How many bonds will the...

The Cost of Debt and Flotation Costs
Suppose a company will issue new 20-year debt with a par value
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will be $1,000. The tax rate is 40%. If the flotation cost is 2% of
the issue proceeds, then what is the after-tax cost of debt? What
if the flotation costs were 10% of the bond issue?

The Cost of Debt and Flotation Costs.
Suppose a company will issue new 25-year debt with a par value
of $1,000 and a coupon rate of 10%, paid annually. The issue price
will be $1,000. The tax rate is 35%. If the flotation cost is 5% of
the issue proceeds, then what is the after-tax cost of debt?
Disregard the tax shield from the amortization of flotation costs.
Round your answer to two decimal places.
What if the flotation...

Individual
or component costs of
capital)
Compute the cost of the following:a. A bond that has
$1,000
par value (face value) and a contract or coupon interest rate
of
9
percent. A new issue would have a floatation cost of
9
percent of the
$1,130
market value. The bonds mature in
15
years. The firm's average tax rate is 30 percent and its
marginal tax rate is
35
percent.b. A new common stock issue that paid a
$1.80
dividend last...

(Individual
or component costs of
capital)
Compute the cost of the following:
. A preferred stock paying a dividend of
12
percent on a
$150
par value. If a new issue is offered, flotation costs will
be
9
percent of the current price of
$163
e. A bond selling to yield
12
percent after flotation costs, but before adjusting for the
marginal corporate tax rate of
33
percent. In other words,
12
percent is the rate that equates the net...

A firm’s capital structure consists of 21% long-term debt. At
present, the company can raise debt by selling 17-year bonds with a
11.82% annual coupon interest rate. The firm is in a 32% income tax
bracket. Its bonds generally require an average discount of $40.92
per bond and flotation costs of $34.91 per bond when being sold.
Required: Calculate the firm’s current after-tax cost of long-term
debt.

Cost of Capital (WACC):
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bonds with a 10% coupon rate. The company believes it can sell the
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The bond sold at $515.16 with semiannual coupon payments. The...

(Individual or Component Costs of Capital) Compute the cost for
the following
sources of Financing:
a. A bond that has a $1,000 par value (face value) and a contract
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of the
$1,125 market value. The bonds mature in 10 years. The firm’s
average tax
rate is 30% and its marginal tax rate is 34%.
b. A new common stock issue paid a $1.75 dividend...

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