Question

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Jorn Co is in need of approximately $2,000,000 to finance the purchasing of equipment and inventory for a business expansion. They are trying to decide between the three following scenarios: Option 1: Issuing $3,000,000 in 10-year bonds with an annual 4% coupon rate. Similar bonds have a 9% market rate. Option 2: Issuing $1,500,000 in 10-year bonds with an annual 13% coupon rate. Similar bonds have an 8% market rate. Option 3: Issuing a 10-year $5,000,000 zero-interest-bearing note with an implicit rate of 9.5%. Part A. For each scenario, prepare the amortization table for the first 2 full years. Part B. Besides the difference in market rates, what else should Jorn take into consideration when making their decision?

Answer 1

Option 1
Year	Coupon Amount @4 %	Present Value Factor @ 9%	Present Value Amount
1	120000	0.9174	110091.74
2	120000	0.8417	101001.60
3	120000	0.7722	92662.02
4	120000	0.7084	85011.03
5	120000	0.6499	77991.77
6	120000	0.5963	71552.08
7	120000	0.5470	65644.11
8	120000	0.5019	60223.95
9	120000	0.4604	55251.33
10	120000	0.4224	50689.30
		Implicit Value of Bond	770118.92
Amortistaion Table
Year	Opening Balance	Interest @ 9%	Coupon Paid	Closing Balance
1	770118.92	69310.70317	120000	719429.63
2	719429.63	64748.66646	120000	664178.29
Option 2
Year	Coupon Amount @13 %	Present Value Factor @ 8%	Present Value Amount
1	195000	0.9259	180555.56
2	195000	0.8573	167181.07
3	195000	0.7938	154797.29
4	195000	0.7350	143330.82
5	195000	0.6806	132713.72
6	195000	0.6302	122883.08
7	195000	0.5835	113780.63
8	195000	0.5403	105352.43
9	195000	0.5002	97548.55
10	195000	0.4632	90322.73
		Implicit Value of Bond	1308465.87
Amortistaion Table
Year	Opening Balance	Interest @ 8%	Coupon Paid	Closing Balance
1	1308465.87	104677.2698	195000	1218143.14
2	1218143.14	97451.45141	195000	1120594.59
Option 3	Implicit Value of Bond	2017570.9337
	(5000000/(1.095)10
Amortistaion Table
Year	Opening Balance	Interest @ 9.5%	Coupon Paid	Closing Balance
1	2017570.93	191669.2387	0	2209240.17
2	2209240.17	209877.8164	0	2419117.99

PART B Besides the difference in the Market Rate, Jorn has to taken into the following factors

1. Liquidity : First two options require payment of regular coupn amount where as option 3 doest not have such obligation. therefore , if the firm is not having enough liquidity available with them, they should opt option 3 .

2. Effective cost of Fund: Despite the fact Option 3 does not require payment of regular coupon amount , it is the costlier mode of raising fund , amongst the above, Option 1 gives the cheapest financing alternative.