A real estate development company wants to issue a 10-year corporate bond worth € 10 million....
A real estate development company wants to issue a 10-year
corporate bond worth € 10 million. The company has the following
options:
a) To make the issue of corporate bonds by public offering. In this
case the bond will be sold at par, the yield is 8%, the cost of the
contractor is 0.5% of the nominal value of the bond and we assume
that there are no other costs associated with its issue.
b) To make the issue of the corporate bond by private placement. In
this case it will be sold at par, its yield is 8.125% and the cost
of the private placement is assumed to be 20,000 €.
If the discount rate is 8% and the coupon is paid annually, compare
the two above scenarios and show which of the two options the
company would prefer.
Homework Answers
Comparing the Two Options from the scenarios:
OPTION 1).
Value of Bond = € 10 million
Cost of contractor = 0.5%
Net proceeds of Bond = € 10 million(1-.005)
= € 9.95 million
Bond Yield = 8%
Interest amount annually= € 10 million*8%: = € 0.8 million
Discount Rate= 8%
Calculating the Present Value of Outflow of Interest and Principal of Bond (€ in million):
PV= € 9.998 million
Net Outflow = PV of Outflow- Initial Inflow or proceeds
= € 9.998 million - € 9.95 million
= € 48000
OPTION 2).
Value of Bond = € 10 million
Cost of Private Placement = € 20000
Net proceeds of Bond = € 10 million -€ 20000
= € 9.98 million
Bond Yield = 8.125%
Interest amount annually= € 10 million*8.125%: = € 0.8125 million
Discount Rate= 8%
Calculating the Present Value of Outflow of Interest and Principal of Bond (€ in million):
PV= € 10.08 million
Net Outflow = PV of Outflow- Initial Inflow or proceeds
= € 10.08 million - € 9.98 million
= € 100,000
Since, Net outflow of Bonds in Option 1 is € 48000 while of Option 2 is € 100,000.
So, Company should go for Option 1 as less outflow of bonds.
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