Question

You need to choose between making a public offering and arranging a private placement. In each case the issue involves $9.5 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 8.25%, and the debt would be issued at face value. The underwriting spread would be 1.15%, and other expenses would be $75,000. A private placement: The interest rate on the private placement would be 8.6%, but the total issuing expenses would be only $25,000.

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 PV 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?

• Public issue

• Private placement

Answer 1

a-1. Face Value (A) = $9,500,000

Underwriting Spread (B) = 1.15% of Issue Value

= $109250

Other Expenses (C) = $ 75,000

   Net Proceeds (A) - (B) - (C)    = $9,315,750

a-2.   Face Value (A) = $9,500,000

  Other Expenses (B) = $25,000

  Net Proceed (A) - (B) =   $9,475,000

a-3. (A) Interest Expense in Public Issue = 8.25% of $9,500,000 = $783,750

(B)   Interest Expense in Private Issue = 8.60% of $9,500,000 = $817,000

(C) Extra Interest on Private Issue (B) - (A) = $33250

Assuming Interest Rate of 10%,

PV of Extra Expense on Private Issue   = $33250 (1.10)¹⁰

= $204,306

b-2 Additional Proceeds in Private Issue (A) = $9,475,000 - $9,315,750

  = $159250

Less:  PV of Extra Expense on Private Issue (B)    = $204306

Extra Outflow on Private Issue (B) -(A) = $45056

Considering that there is additional outflow of $45056 on Private Issue, It can be concluded that raising debt through Public IssUe is a better option.