Week 5 Dq

Solutions Guide:

A2.(Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage yield)?

1. n = 40 r = ? PV = -($50 - $1) = -$49 PMT = 9% / 2 x $50 = $2.25 FV = $50 r = 4.61%

APY = (1 + 0.0461)2 -1 = 9.4334%

2. n = 20 r = ? PV = -($50 - $0.5) = -$49.5 PMT = 9.25% x $50 = $4.625 FV = $50 r = 9.36%

APY = 9.36%

Choice 2 has the lower APY.

B5.(Cost of borrowing alternatives) Exxon Mobil has a 34% tax rate and has decided to issue $100 million of seven-year debt. It has three alternatives. A U.S. public offering would require an 8% coupon with interest payable semiannually and $900,000 of flotation expense. A U.S. private placement would require an 8-3/8% coupon with interest payable semiannually and $500,000 of flotation expense. A Eurobond offering would require an 8-1/8% coupon with interest payable annually and $1,100,000 of flotation expense.

Calculate the after-tax cost of borrowing for each alternative.

Which alternative has the lowest cost of borrowing?

a. Public Offering: ATCF yearly cost = -4.0(1-0.34) + (0.34)(0.9/14) = -2.618143

n = 14 r = ? PV = -$99.1 PMT = $2.618143 FV = $100 r = 2.6962%

N=2 I=2.6962 PV=100 PMT=0 FV=-105.4650 so APY = 5.4650%

APY = (1 + 0.026962)2 - 1 = 5.465%

Private Placement: ATCF yearly cost = -4.1875(1-0.34) + (0.34)(0.5/14) = -2.751607

n = 14 r = ? PV = -$99.5 PMT = $2.751607 FV = $100 r = 2.7953%

N=2 I=2.7953 PV=100 PMT=0 FV=-105.6686 so APY = 5.6686%

APY = (1 + 0.027953)2 - 1 = 5.6686%

Eurobond: ATCF yearly cost = -8.125(1-0.34) +...