7. Sunrise, Inc., is trying to determine its cost of debt.

The firm has a debt issue outstanding with 23 years to

maturity that is quoted at 96 percent of face value. The issue makes semiannual payments and has an
embedded cost of 5 percent annually. What is the company’s pretax cost of debt? If the tax rate is 21
percent, what is the aftertax cost of debt?

First, let's calculate the company's pre-tax cost of debt.

The semiannual payment can be calculated using the following formula:

Coupon Payment = Face Value x Coupon Rate / 2

Coupon Payment = $1,000 x 5% / 2

Coupon Payment = $25

The cost of the bond can be calculated using the following formula:

Cost of the bond = (Coupon Payment / Current Market Price) + YTM

YTM is the yield to maturity.

We'll assume the yield to maturity is 5%, since the bond is quoted at 96% of face value, and the embedded
cost is 5% annually.

Cost of the bond = ($25 / 0.96) + 0.05

Cost of the bond = $26.04 + 0.05

Cost of the bond = $26.09

Now let's convert this into an annual rate: $26.09 / $1,000 = 0.02609 or 2.61%

So, the company's pre-tax cost of debt is 2.61%.

Now, let's calculate the after-tax cost of debt.

The after-tax cost of debt is given by the formula:

After-tax cost of debt = Pre-tax cost of debt x (1 - Tax Rate)

After-tax cost of debt = 2.61% x (1 - 0.21)

After-tax cost of debt = 2.61% x 0.79

After-tax cost of debt = 2.06%

So, the company's after-tax cost of debt is 2.06%.