3.3 You need to choose between making a public offering and arranging a private

Question

3.3 You need to choose between making a public offering and arranging a private
placement. In each case the issue involves $10 million face value of 10-year debt. You
have the following data for each:
o A public issue: The interest rate on the debt would be 8.5%, and the debt would be
issued at face value. The underwriting spread would be 1.5%, and other expenses
would be $80,000.
o A private placement: The interest rate on the private placement would be 9%, but the
total issuing expenses would be only $30,000.
a) What is the difference in the proceeds to the company net of expenses?
b) Others things being equal, which is the better deal?
c) What other factors beyond the interest rate and issue costs would you wish to consider
before deciding between the two offers?

Explanation / Answer

(a) Net proceeds of public issue=10,000,000-150,000-80,000=$9,770,000; Net proceeds of private placement=$9,970,000. (b) PV of extra interest on private placement=$328,000, i.e., extra cost of higher interest on private placement more than outweighs saving in issue costs. We ignore taxes. (c) Private placement debt can be custom-tailored and the terms more easily renegotiated.

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