Comparison of private and public debt offering.
The Landers Corporation needs to raise $1 million of debt on a 25-year issue. If it places the bonds privately, the interest rate will be 11 percent. Thirty thousand dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 10 percent, and the underwriting spread will be 4 percent. There will be $100,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 25 year period, at which time it will be repaid.
Which plan offers the higher net present value? For each plan, compare the net amount of funds initially available?inflow?to the present value of future payments of interest and principal to determine net present value. Assume the stated discount rate is 12 percent annually. Use 6 percent semiannually throughout the analysis. (Disregard taxes.)
To compute present values (i.e., present value of interest payments) use the MS Excel PV function.
Information provided:
Debt $1,000,000
Years 25
Interest rate (private placement) 11%
Out-of-pocket costs (private placement) $30,000
Interest rate (public placement) 10%
Underwriting spread 4%
Out-of-pocket costs (public placement) $100,000
Stated discount rate 12%
Private Public
Present value of interest payments
Present value of maturity value