The cost of debt increases relative to the investor's required return due to flotation costs,but decreases relative to the investor's required return due to the tax deductibility of interest.

Question

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Flotation costs (costs associated with issuing new debt) increase the effective cost of borrowing for the company, which in turn increases the required return for investors. However, the tax deductibility of interest payments reduces the after-tax cost of borrowing for the company, which decreases the required return for investors. Overall, the net effect depends on the magnitude of these two factors and other factors that may affect the credit risk, liquidity, and market conditions of the company's debt.

The Cost of Debt Increases Relative to the Investor's Required