Question

The Landers Corporation needs to raise $1.70 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 12 percent. Twenty five thousand dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 11 percent, and the underwriting spread will be 3 percent. There will be $110,000 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. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

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 14 percent annually. Use 7.00 percent semiannually throughout the analysis. (Disregard taxes.) (Assume the $1.70 million needed includes the underwriting costs. Input your present value of future payments answers as negative values. Do not round intermediate calculations and round your answers to 2 decimal places.)

private placement Public Issue

Net amt to Landers ___________ _________________

Present value of future payments _____________ ______________

NPV ____________ ________________

Answer 1

a. Plan - Private issue

Net proceeds = 1,700,000 - 25,000 = 1,675,000

Interest payment = 1,700,000 * 12% * 1/2 = 102,000

Present value of the bond proceeds = Present value of interests + Present value of redemption amount

= (102,000 * PVIFA 7% ,40) + (1,700,000 * PVIF 7% , 40th period)

= (102,000 * 13.332) + (1,700,000 * 0.067)

= 1,473,764

Present value of future payments = 1,675,000 - 1,473,764 = 201,236

b. Plan - Public issue

Underwriting spread = 1,700,000 * 3% = 51,000

Net proceeds = 1,700,000 - 51,000 - 110,000 = 1,539,000

Interest payment = 1,700,000 * 11% * 1/2 = 93500

Present value of the bond proceeds = Present value of interests + Present value of redemption amount

= (93500 * PVIFA 7% ,40) + (1,700,000 * PVIF 7% , 40th period)

= (93500 * 13.332) + (1,700,000 * 0.067)

= 1,360,442

Present value of future payments = 1,539,000 - 1,360,442 = 178,558