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IBM wishes to raise $1 billion and is trying to decide between a domestic dollar bond issue and a Eurobond issue. The U.S. bond can be issued at a coupon of 6.75 percent, paid semiannually, with underwriting and other expenses totaling 0.95 percent of the issue size. The Eurobond would cost only 0.55 percent to issue but would bear an annual coupon of 6.88 percent. Both issues would mature in ten years.
a. Assuming all else is equal, which is the least expensive issue for IBM?
b. What other factors might IBM want to consider before deciding which bond to issue?
a. In order to find the least expensive option, we need to compare the Yield to Maturity (YTM) of the two options. The YTM is nothing but the IRR or the rate of return available for a given market price. In calculating YTM to IBM, we also need to consider the floatation costs by reducing the amount available to IBM. In the domestic issue, assuming $1000 face value, floatation costs would be 0.95% or $9.5 and the net proceed would be 990.5. The YTM to ba calculated on this price. For Euro bond, the ...
The solution explains how to calculate the effective cost of borrowing - domestic bond issue versus eurobond issue