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How Corporations Issue Securities : Interest Rate, Issue Cost and Company Expense, Private Placements and Public Issues

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:

A public issue: The interest rate on the debt would be 8.5 percent, and the debt would be issued at face value. The underwriting spread would be 1.5 percent and other expenses would be $80,000.

A private placement: The interest rate on the private placement would be 9 percent but the total issuing expenses would be only $30,000.

a. What is the difference in the proceeds to the company net of expense?

b. Other 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?

Solution Preview

a.
1). A public issue:
net of expense = I(interest) + O(othe expense) = $10million *0.085*10 + 80,000 = 8,580,000
proceeds to the company = gross sales - underwriting spread - net of expense = $10million - 0.015 * $10million - 8,580,000 = $1,270,000
2). Private placement:
net of expense = I(interest) + O(othe expense) = $10million * 0.09 * 10 + $30,000 = 9,030,000
proceeds to the company = gross sales - underwriting spread - net of expense = $10million - 9,030,000 = 970,000

b. In terms of the proceeds to the company, public issue is better.

c. Private placement bonds differ from publicly offered bonds in three key areas: (1) the
design of bond covenants, (2) credit monitoring, and (3) the relatively ease of renegotiation.

private debts, whose terms could be modified throughout the life of the debt contract upon mutual agreement between the borrower and the
lender, are more likely to have restrictive covenants than public debts. In fact, in a public ...

Solution Summary

How Corporations Issue Securities, Interest Rate, Issue Cost and Company Expense, Private Placements and Public Issues are investigated. The solution is detailed and well presented.

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