What is the effective cost of debt for Joliet Company if the bonds are sold for $1,120 with flotation costs?

To determine the effective cost of debt for Joliet Company when the bonds are sold for $1,120 with flotation costs, you must calculate the yield to maturity (YTM) of the bonds, considering the selling price and the flotation costs involved.

First, if the bonds are sold above their par value (usually $1,000), this indicates that the effective interest rate or the cost of debt will be lower than the coupon rate because investors are willing to pay more than the par value to receive interest payments.

In this scenario, if the bonds are sold for $1,120, it implies that the company is receiving extra cash from the investors, which influences the overall cost of financing through debt. The flotation costs are a crucial factor as they represent the costs incurred to issue the bonds, which can also affect the overall cost calculation.

When you calculate the cost of debt, you would typically factor in the annual coupon payment and the net proceeds received after deducting flotation costs. If you assume a nominal coupon interest rate, you can compute the effective cost using the formula:

[ \text{Cost of Debt} = \frac{\text{Annual Interest Payment}}{\text{Net Proceeds}} ]

The "Net Proceeds" would take