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Rights. In 2001 Pandora, Inc., makes a rights issue at a subscription price of $5 a share. One new share can be purchased for every four shares held. Before the issue there were 10 million shares outstanding and the share price was $6.

a. What is the total amount of new money raised?

b. What is the expected stock price after the rights are issued?

16. Rights. Problem 15 contains details of a rights offering by Pandora. Suppose that the company had decided to issue the new stock at $4 instead of $5 a share. How many new shares would it have needed to raise the same sum of money? Recalculate the answers to problem

15. Show that Pandora`s shareholders are just as well off if it issues the shares at $4 a share rather than the $5 assumed in problem 15.

17. Rights. Consolidated Jewels needs to raise $2 million to pay for its Diamonds in the Rough campaign. It will raise the funds by offering 200,000 rights, each of which entitles the owner to buy one new share. The company currently has outstanding 1 million shares priced at $20 each.

a. What must be the subscription price on the rights the company plans to offer?

b. What will be the share price after the rights issue?

c. What is the value of a right to buy one share?

d. How many rights would be issued to an investor who currently owns 1,000 shares?

e. Show that the investor who currently holds 1,000 shares is unaffected by the rights issue. Specifically, show that the value of the rights plus the value of the 1,000 shares after the rights issue equals the value of the 1,000 shares before the rights issue.

18. Rights. Associated Breweries is planning to market unleaded beer. To finance the venture it proposes to make a rights issue with a subscription price of $10. One new share can be purchased for each two shares held. The company currently has outstanding 100,000 shares priced at $40 a share. Assuming that the new money is invested to earn a fair return, give values for the

a. number of new shares

b. amount of new investment

c. total value of company after issue

d. total number of shares after issue

e. share price after the issue

19. Venture Capital. Here is a difficult question. Pickwick Electronics is a new high-tech company financed entirely by 1 million ordinary shares, all of which are owned by George Pickwick. The firm needs to raise $1 million now for stage 1 and, assuming all goes well, a further $1 million at the end of 5 years for stage 2. First Cookham Venture Partners is considering two possible financing schemes: Buying 2 million shares now at their current valuation of $1. Buying 1 million shares at the current valuation and investing a further $1 million at the end of 5 years at whatever the shares are worth.

The outlook for Pickwick is uncertain, but as long as the company can secure the additional finance for stage 2, it will be worth either $2 million or $12 million after completing stage 2. (The company will be valueless if it cannot raise the funds for stage 2.) Show the possible payoffs for Mr. Pickwick and First Cookham and explain why one scheme might be preferred. Assume an interest rate of zero.

1 Unless the firm can secure second-stage financing, it is unlikely to succeed. If the entrepreneur is going to reap any reward on his own investment, he needs to put in enough effort to get further financing. By accepting only part of the necessary venture capital, management increases its own risk and reduces that of the venture capitalist. This decision would be costly and foolish if management lacked confidence that the project would be successful enough to get past the first stage. A credible signal by management is one that only managers who are truly confident can afford to provide. However, words are cheap and there is little to be lost by saying that you are confident (although if you are proved wrong, you may find it difficult to raise money a second time).

2 If an investor can distinguish between overpriced and underpriced issues, she will bid only on the underpriced ones. In this case she will purchase only issues that provide a 10 percent gain. However, the ability to distinguish these issues requires considerable insight and research. The return to the informed IPO participant may be viewed as a return on the resources expended to become informed.

3 Direct expenses: Underwriting spread = 69 million ГЧ $4 $ 276.0 million Other expenses 9.2 Total direct expenses $ 285.2 million

Underpricing = 69 million ГЧ ($70 Ј $64) $ 414.0 million Total expenses $ 699.2 million Market value of issue = 69 million ГЧ $70 $4,830.0 million Expenses as proportion of market value = 699.2/4,830 = .145 = 14.5%.

4 Ten issues of $15 million each will cost about 9 percent of proceeds, or .09 ГЧ $150 million = $13.5 million. One issue of $150 million will cost only 4 percent of $150 million, or $6 million.

Pet.Com was founded in 1997 by two graduates of the University of Wisconsin with help from Georgina Sloberg, who had built up an enviable reputation for backing new start-up businesses. Pet.Com`s user-friendly system was designed to find buyers for unwanted pets. Within 3 years the company was generating revenues of $3.4 million a year, and, despite racking up sizable losses, was regarded by investors as one of the hottest new e-commerce businesses. The news that the company was preparing to go public therefore generated considerable excitement.

The company`s entire equity capital of 1.5 million shares was owned by the two founders and Ms. Sloberg. The initial public offering involved the sale of 500,000 shares by the three existing shareholders, together with the sale of a further 750,000 shares by the company in order to provide funds for expansion.

The company estimated that the issue would involve legal fees, auditing, printing, and other expenses of $1.3 million, which would be shared proportionately between the selling shareholders and the company. In addition, the company agreed to pay the underwriters a spread of $1.25 per share.

The road show had confirmed the high level of interest in the issue, and indications from investors suggested that the entire issue could be sold at a price of $24 a share. The underwriters, however, cautioned about being too greedy on price. They pointed out that indications from investors were not the same as firm orders. Also, they argued, it was much more important to have a successful issue than to have a group of disgruntled shareholders. They therefore suggested an issue price of $18 a share.

That evening Pet.Com`s financial manager decided to run through some calculations. First she worked out the net receipts to the company and the existing shareholders assuming that the stock was sold for $18 a share. Next she looked at the various costs of the IPO and tried to judge how they stacked up against the typical costs for similar IPOs. That brought her up against the question of underpricing. When she had raised the matter with the underwriters that morning, they had dismissed the notion that the initial day`s return on an IPO should be considered part of the issue costs. One of the members of the underwriting team had asked: ¬The underwriters want to see a high return and a high stock price. Would Pet.Com prefer a low stock price? Would that make the issue less costly? ­ Pet.Com`s financial manager was not convinced but felt that she should have a good answer. She wondered whether underpricing was only a problem because the existing shareholders were selling part of their holdings. Perhaps the issue price would not matter if they had not planned to sell.