Question

The Landry Corporation needs to raise $1.30 million of debt on a 15-year issue. If it places the bonds privately, the interest rate will be 11 percent, and $35,000 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 $150,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 15 years, at which time it will be repaid. (Use a Financial calculator to arrive at the answers.) The Landry Corporation needs to raise $1.30 million of debt on a 15-year issue. If it places the bonds privately, the interest rate will be 11 percent, and $35,000 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 $150,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 15 years, at which time it will be repaid. (Use a Financial calculator to arrive at the answers.) a. 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, but use 6.00 percent semiannually throughout the analysis. (Disregard taxes.) (Negative answers should be indicated by a minus sign. Do not round intermediate calculations. Enter the answers in dollars not in millions. Omit $ sign in your response. Round the final answer to the nearest whole dollar.).

Answer 1

For Private Placement

Net Amount to Landers = $1,300,000 - $35,000 = $1,265,000

Present Value of Future Payments = $ - 1,210,529 [Using the excel formula as =PV(6%,15*2,1300000*11%/2,1300000) ]

Net Present Value = $1,265,000 - $1,210,529 = $54,471

For Public Issue

Net Amount to Landers =$1,300,000 - $150,000 - $1,300,000 * 4% = $1,098,000

Present Value of Future Payments = $ - 1,121,057 [Using the excel formula as =PV(6%,15*2,1300000*10%/2,1300000) ]

Net Present Value = $1,098,000 - $1,121,057 = $ - 23,057

In Conclusion

	Private Placement	Public Issue
Net Amount to Landers	$1,265,000	$1,098,000
Present Value of future payments	-$1,210,529	-$1,121,057
Net Present Value	$54,471	-$23,057

Hence, based on above data, private placement is preferable as it offers higher Net Present Value.

Note:- The Present value can also be calculated by multiplying the Semi-annual interest by Cummulative PV Factor (15*2 Period, 12%/2) and multipling redemption/maturity amount by PV Factor (15 Years, 12%) instead of using the excel formulas and the result would be the same.

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