The Landers Corporation needs to raise $1.6 million of debt on a 20-year issue.
ID: 2577291 • Letter: T
Question
The Landers Corporation needs to raise $1.6 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 10 percent. Twenty thousand dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 9 percent, and the underwriting spread will be 2 percent. There will be $120,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 20-year period, at which time it will be repaid. Which plan offers the higher net present value? 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 percent semiannually throughout the analysis. (Disregard taxes.) The Landers Corporation needs to raise $1.6 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 10 percent. Twenty thousand dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 9 percent, and the underwriting spread will be 2 percent. There will be $120,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 20-year period, at which time it will be repaid. Which plan offers the higher net present value? 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 percent semiannually throughout the analysis. (Disregard taxes.)Explanation / Answer
private placement
net amount of funds initially available = debt amount - out of pocket expenses
= 1600000 - 20000
=$1580000
inflow:
present value of future interest payment
interest rate = 10 / 2 = 5%
interest = 1600000 * 5% = $ 80000
present value of interest= amount * PVAF (6% , 40 periods)
= 80000 *15.0463
= $ 1203704
present value of lump sum payment at maturity = debt amount * pvf (6%, 40th period)
= 1600000 * 0.09722
= $ 155552
total present value = $1203704 + 155552
=$1359256
NPV of private placement = net amount to lenders - total present value of future payments
=1580000 - 1359256
=$ 220744
public issue :
net amount of funds initially available = debt amount - out of pocket expenses - 2% spread
=1600000 - 120000 - 32000
= $ 1448000
inflow :
present value of future interest payment
interest rate = 9 / 2 = 4.5%
interest = 1600000* 4.5%
=$ 72000
present value of interest= amount * PVAF (6% , 40 periods)
= 72000 *15.0463
= $1083334
present value of lump sum payment at maturity = debt amount * pvf (6%, 40th period)
= 1600000*0.09722
= $ 155552
total present value = 1083334 + 155552
=$ 1238886
NPV of public issue = net amount to lenders - total present value of future payments
=1448000 - 1238886
=$ 209114
from above , private plan offer higher net present value .
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