Final answer:
Sunrise, Inc.'s pretax cost of debt is approximately 4.26%.
Step-by-step explanation:
The cost of debt refers to the interest rate that a company pays on its outstanding debt. In this case, Sunrise, Inc. has a debt issue outstanding with 23 years to maturity, quoted at 96% of face value. The issue makes semiannual payments and has an embedded cost of 5% annually. The pretax cost of debt can be calculated by finding the yield to maturity (YTM) on the bond. To calculate the YTM, we need to use the following formula:
YTM = (C / (F - P)) * (1 / t) + (I / (t * F))
Where:
- C = periodic coupon payment
- F = face value of the bond
- P = market price of the bond
- t = number of periods remaining until maturity
- I = annual interest payment
Other variables in this equation are:
- C = ($5,000 * 8%) / 2 = $200
- F = $5,000
- P = $5,000 * 96% = $4,800
- t = 23 * 2 = 46
- I = ($5,000 * 8%) = $400
Using these values, we can substitute them into the YTM formula as follows:
YTM = ($200 / ($5,000 - $4,800)) * (1 / 46) + ($400 / (46 * $5,000)) = 0.0424 + 0.000176 = 0.042576
Therefore, the pretax cost of debt for Sunrise, Inc. is approximately 4.26%.