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Venture Capital

Underwriting.

a. Is a rights issue more likely to be used for an initial public offering or for subsequent issues of stock?

b. Is a private placement more likely to be used for issues of seasoned stock or seasoned bonds by an industrial company?

c. Is shelf registration more likely to be used for issues of unseasoned stocks or bonds by a large industrial company?

2. Underwriting. Each of the following terms is associated with one of the events beneath.

Can you match them up?

a. Shelf registration

b. Firm commitment

c. Rights issue

A. The underwriter agrees to buy the issue from the company at a fixed price.

B. The company offers to sell stock to existing stockholders.

C. Several issues of the same security may be sold under the same registration.

3. Underwriting Costs. State for each of the following pairs of issues which you would expect to involve the lower proportionate underwriting and administrative costs, other things equal:

a. A large issue/a small issue

b. A bond issue/a common stock issue

c. A small private placement of bonds/a small general cash offer of bonds

4. IPO Costs. Why are the issue costs for debt issues generally less than those for equity issues?

5. Venture Capital. Why do venture capital companies prefer to advance money in stages?

6. IPOs. Your broker calls and says that you can get 500 shares of an imminent IPO at the offering price. Should you buy? Are you worried about the fact that your broker called you?

7. IPO Underpricing. Having heard about IPO underpricing, I put in an order to my broker for 1,000 shares of every IPO he can get for me. After 3 months, my investment record is as follows:

a. What is the average underpricing of this sample of IPOs?

b. What is the average initial return on my БІАААмportfolioБІАААн of shares purchased from the four

IPOs I bid on? Calculate the average initial return, weighting by the amount of money invested in each issue.

c. Why have I performed so poorly relative to the average initial return on the full sample of IPOs? What lessons do you draw from my experience?

8. IPO Costs. Moonscape has just completed an initial public offering. The firm sold 3 million shares at an offer price of $8 per share. The underwriting spread was $.50 a share. The price of the stock closed at $11 per share at the end of the first day of trading. The firm incurred $100,000 in legal, administrative, and other costs. What were flotation costs as a fraction of funds raised? Were flotation costs for Moonscape higher or lower than is typical for IPOs of this size (see Table 5.10)?

9. IPO Costs. Look at the illustrative new issue prospectus in the appendix.

a. Is this issue a primary offering, a secondary offering, or both?

b. What are the direct costs of the issue as a percentage of the total proceeds? Are these more than the average for an issue of this size?

c. Suppose that on the first day of trading the price of Hotch Pot stock is $15 a share. What are the total costs of the issue as a percentage of the market price?

d. After paying her share of the expenses, how much will the firm`s president, Emma Lucullus, receive from the sale? What will be the value of the shares that she retains in the company?

10. Flotation Costs. БІАААмFor small issues of common stock, the costs of flotation amount to about 15 percent of the proceeds. This means that the opportunity cost of external equity capital is about 15 percentage points higher than that of retained earnings.БІАААн Does this follow?

11. Flotation Costs. When Microsoft went public, the company sold 2 million new shares (the primary issue). In addition, existing shareholders sold .8 million shares (the secondary issue) and kept 21.1 million shares. The new shares were offered to the public at $21 and the underwriters received a spread of $1.31 a share. At the end of the first day`s trading the market price was $35 a share.

a. How much money did the company receive before paying its portion of the direct costs?

b. How much did the existing shareholders receive from the sale before paying their portion of the direct costs?

c. If the issue had been sold to the underwriters for $30 a share, how many shares would the company have needed to sell to raise the same amount of cash?

d. How much better off would the existing shareholders have been?

12. Flotation Costs. The market value of the marketing research firm Fax Facts is $600 million. The firm issues an additional $100 million of stock, but as a result the stock price falls by 2 percent. What is the cost of the price drop to existing shareholders as a fraction of the funds raised?

13. Flotation Costs. Young Corporation stock currently sells for $30 per share. There are 1 million shares currently outstanding. The company announces plans to raise $3 million by offering shares to the public at a price of $30 per share.

a. If the underwriting spread is 8 percent, how many shares will the company need to issue in order to be left with net proceeds of $3 million?

b. If other administrative costs are $60,000 what is the dollar value of the total direct costs of the issue?

c. If the share price falls by 3 percent at the announcement of the plans to proceed with a seasoned offering, what is the dollar cost of the announcement effect?

14. Private Placements. You need to choose between the following types of issues: A public issue of $10 million face value of 10-year debt. 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 of $10 million face value of 10-year debt. 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 expenses?

b. Other things 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?