Today 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 availableinflowto 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.)

Solution Problem 15-17

Instructions

Enter formulas and functions to complete the requirements of this problem. To compute present values (i.e., present value of interest payments) use the MS Excel PV function.

Information provided:

Debt $1,600,000

Years 20

Interest rate (private placement) 10%

Out-of-pocket costs (private placement) $20,000

Interest rate (public placement) 9%

Underwriting spread 2%

Out-of-pocket costs (public placement) $120,000

Stated discount rate 12%

Private Public

Debt issue $1,600,000 FORMULA

Out-of-pocket costs (20,000) FORMULA

Spread FORMULA FORMULA

Net amount to Landers 1,580,000 FORMULA

Interest payments (semiannual) FORMULA FORMULA

Present value of interest payments 80,000 FORMULA

Present value of maturity value 1,359,259 FORMULA

Net present value 220,741 FORMULA