The Landers Corporation needs to raise $1.90 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 12 percent.

The Landers Corporation needs to raise $1.90 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 12 percent. Forty 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 4 percent. There will be $140,000 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 $1.90 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 amount to Landers	$	$
Present value of future payments
Net present value	$	$

b.	Which plan offers the higher net present value?
	Private placement

 
Explanation:

a.

Private placement:

Semiannual interest payment	= (Interest rate / 2) × Debt
	= (.12 / 2) × $1,900,000
	= $114,000

Net amount	= Debt – Costs
	= $1,900,000 – 40,000
	= $1,860,000

PV of future payments	= PV of interest payments + PV of principal repayment
	= ($114,000 × {[1 – (1 / 1.0740)] / .07}) + ($1,900,000 / 1.0740)
	= $1,646,697.53

NPV	= Net amount – PV of future payments
	= $1,860,000 – 1,646,697.53
	= $213,302.47

Public issue:

Semiannual interest payment	= (Interest rate / 2) × Debt
	= (.11 / 2) × $1,900,000
	= $104,500

Net amount	= [Debt × (1 – Spread)] – Costs
	= [$1,900,000 × (1 – .04)] – $140,000
	= $1,684,000

PV of future payments	= PV of interest payments + PV of principal repayment
	= ($104,500 × {[1 – (1 / 1.0740)] / .07}) + ($1,900,000 / 1.0740)
	= $1,520,046.30

NPV	= Net amount – PV of future payments
	= $1,684,000 – 1,520,046.30
	= $163,953.70

Calculator Solution:

a.

Private placement:

	N			I/Y			PV			PMT			FV
40			7			CPT PV –1,646,697.53			114,000			1,900,000

Answer: $1,646,697.53

Public issue:

	N			I/Y			PV			PMT			FV
40			7			CPT PV –1,520,046.30			104,500			1,900,000

Answer: $1,520,046.30

Appendix Solution:

a.

Private placement – PV of future payments:

Appendix D and B

PV	= (A × PVIFA (7%, 40)) + (FV × PVIF (7%, 40))
	= ($114,000 × 13.332) + ($1,900,000 × .067)
	= $1,647,148

Public issue – PV of future payments:

Appendix D and B

PV	= (A × PVIFA (7%, 40)) + (FV × PVIF (7%, 40))
	= ($104,500 × 13.332) + ($1,900,000 × .067)
	= $1,520,494