The Landers Corporation needs to raise $1.70 million of debt on a 20-year issue.

Question

The Landers Corporation needs to raise $1.70 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 12 percent. 25000 dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 11 percent, and the underwriting spread will be 3 percent. There will be $110,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 20-year period, at which time it will be repaid. Use Appendix B and Appendix D.

(a)

For each plan, compare the net amount of funds initially available

Explanation / Answer

Private Placement

$1,000,000    debt

    – 30,000     out-of-pocket costs

$   970,000            net amount to Landers

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Present value of future interest payments

interest payments (semiannually) = 11%/2 = 5.5%

interest payments = 5.5% ´ $1,000,000 = $55,000

PVA = A ´ PVIFA (n = 50, i = 6%)

PVA = $55,000 ´ 15.762   

PVA = $866,910

Present value of lump-sum payment at maturity

PV = FV ´ PVIF (n = 50, i = 6%)

PV = $1,000,000 x .054  =

PV = $54,000

          Total present value of interest and maturity payments

The net present value equals the net amount to Landers minus the present value of future payments.

Public Issue

Present value of future interest payments

interest payments (semiannually) = 10%/2 = 5%

interest payments = 5% ´ $1,000,000 = $50,000

PVA = A ´ PVIFA (n = 50, i = 6%)

PVA = $50,000 ´ 15.762

PVA = $788,100

Present value of lump-sum payment at maturity

PV    = FV ´ PVIF (n = 50, i = 6%)

PV    = $1,000,000 ´ .054   (

PV    = $54,000

Total present value of interest and maturity payments

Net present value equals the net amount to Landers minus the present value of future payments

The private placement has the higher net present value ($49,090 vs. $17,900)

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