Question

You need to choose between making a public offering and arranging a private placement. In each case, the issue involves $9.3 million face value of 10-year debt. You have the following data for each:

A public issue: The interest rate on the debt would be 8.15%, and the debt would be issued at face value. The underwriting spread would be 1.67%, and other expenses would be $73,000.

A private placement: The interest rate on the private placement would be 8.9%, but the total issuing expenses would be only $23,000.

a-1. Calculate the net proceeds from public issue.

a-2. Calculate the net proceeds from private placement.

b-1. Calculate the Present Value of the extra interest on the private placement.

b-2. Other things being equal, which is the better deal?

Answer 1

Solution:
	Issue amount Face Value	9300000
a-1)	Net Proceeds from Public Issue
	Face Value	93,000,000
	Underwriters spread @ 1.67%	(155,310)
	Other Expenses	(73,000)
	Net Proceeds	92,771,690
a-2.)	Net Proceeds from Private Placement
	Face Value	93,000,000
	Other Expenses	(23,000)
	Net Proceeds	92,977,000
b-1)	Present Value of the extra interest paid on private placement
	Interest rate on Public Issue	8.15%
	Interest rate on Private Placement	8.90%
	Differential Interest rate per annum	=8.9-8.15
		=0.65%
	Differential Interest amount per annum	=93000000*.65%
		=604500
	Present Value of the extra interest paid over 10 years
	PV (Annuity)	=CF*((1-(1+r)^-n))/r
		=604500*((1-(1.089)^-10)/.089)
		=604500*(1-0.426306)/.089
		=604500*0.573694/.089
		=3,896,607
b-2)	Amount of issue expenses saved on private placement is $ 205,310 ( $ 92,977,000-92,771,690)
	However, Present Value of the extra interest payments in Private placement, for the next 10 years works out to $ 3,896,607
	Hence ,Public offering is a better deal as it results in a net saving of $ 3,691,297