Final answer:
The pre-tax cost of debt for Sunrise, Inc. can be roughly estimated from the bond's annual coupon rate and discounted for tax purposes to find the after-tax cost of debt, approximately 3.95% based on a 21% tax rate. This is only an approximation and the actual value would depend on the precise yield to maturity calculation.
Step-by-step explanation:
The pre-tax cost of debt for Sunrise, Inc. can be calculated using the yield to maturity method because the bond is traded at a discount (96 percent of the face value) and has semiannual payments. Since the bond pays semiannual coupons, the stated annual interest rate (embedded cost) should also be halved for the calculation, which gives us 2.5% semiannually.
To find the yield to maturity, we would solve for 'i' in the bond pricing formula which equates the present value of future coupon flows and the repayment of principal to the current market price. However, the exact calculation is not provided here. The pretax cost of debt would be approximately close to the coupon rate if the bond's price is near par value. Assuming a small premium due to the bond trading below par, the cost could be slightly higher than the stated 5% annual rate.
For the after-tax cost of debt, we use:
After-tax cost of debt = Pretax cost of debt × (1 - Tax rate)
If the pretax cost of debt is 5% (as an approximation), the after-tax cost of debt would be:
After-tax cost of debt = 5% × (1 - 0.21) = 3.95%
This value can change depending on the exact calculation of the pretax cost of debt. Therefore, if the company has a different actual market-based pretax cost of debt, this value must be adjusted accordingly.