[2] Investment banks as bond underwriters: Net Present Value of Borrowing (30 po

Question

[2] Investment banks as bond underwriters: Net Present Value of Borrowing (30 points) Company E needs to choose between making a public offering and arranging a private placement. In each case the issue involves 10 million face value of 10-year debt. You have the following data for each: Public issue Size of issue Number of periods Coupon rate Underwriting spread JPMorgan () Underwriting spread Citigroup(*) 10,000,000 10 5.5% 1.00% 1.50% Other costs 90,000 (*) 60% of the issue: (..) 40% of the issue .Private placement Size of issue Number of periods Coupon rate Other costs 10,000,000 10 6.0% 20,000 Calculate a. Total issuance costs with public offering 13 points] b. Total issuance costs with private placement [3 points) C. NPV of borrowing with public offering 18 points] d. NPV of borrowing with private placement [8 points] e. Does company E go for a public offering or a private placement? Why? (8 points]

Explanation / Answer

a. Issuance Cost with Public Offering: JP Morgan Commission + Citi Group Commission + Other Costs

= 10,000,000 *0.01*0.6 + 10,000,000*0.015*0.4 + 90,000 = 60,000 + 60,000 + 90,000 = 210,000

b. Issuance Cost with Private Placement: Other Costs = 20,000

c. NPV of Borrowing with Public Offering : 10,000,000 - 210,000 = 9,790,000

d. NPV of Borrowing with Private Placement: 10,000,000 - 20,000 = 9,980,000

e. Company should go for Priavet Placement as Issuance cost is less in Private Placement.

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