Question

You need to choose between making a public offering and arranging a private placement. In each case, the issue involves $10.5 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 8.75%, and the debt would be issued at face value. The underwriting spread would be 1.55%, and other expenses would be $85,000. A private placement: The interest rate on the private placement would be 9.5%, but the total issuing expenses would be only $35,000.

a-1. Calculate the net proceeds from public issue. (Enter your answer in dollars not millions of dollars.)

a-2. Calculate the net proceeds from private placement. (Enter your answer in dollars not millions of dollars.)

b-1. Calculate the Present Value of the extra interest on the private placement. (Do not round intermediate calculations. Enter your answer in dollars not millions of dollars. Round your answer to the nearest whole dollar amount.)

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

	a-1. Net proceeds of public issue a-2. Net proceeds of private placement b-1. Present value of extra interest b-2. Better deal is

Answer 1

a-1
Calculate net proceeds from public issue as shown below
Face value of debt issue	$10,500,000
Underwriting spread	-$162,750	10500000*1.55%
Other expenses	-$85,000
Net proceeds from public issue	$10,252,250
a-2
Calculate net proceeds from private placement as shown below
Face value of debt issue	$10,500,000
Issue expense	-$35,000
Net proceeds from private issue	$10,465,000
b-1
Additional interest paid on private placement	10500000*(9.5%-8.75%)
Additional interest paid on private placement	$78,750
Present value of extra interest	78750*Annuity factor (i=8.75%,n=10)
Present value of extra interest	78750*6.4889
Present value of extra interest	$511,000
b-2
Present value of extra interest paid of $511,000 is higher than savings in issue expense from private placement
Thus, public placement is better deal