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SOC 202 (384)
Louis Pike (20)


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SOC 202
Louis Pike

CHAPTER15 RAISING CAPITAL Learning Objectives LO1 The venture capital market and its role in the financing of new, high-risk ventures. LO2 How securities are sold to the public and the role of investment banks in the process. LO3 Initial public offerings and some of the costs of going public. LO4 How rights are issued to existing shareholders and how to value those rights Answers to Concepts Review and Critical Thinking Questions 1. (LO2) A company’s internally generated cash flow provides a source of equity financing. For a profitable company, outside equity may never be needed. Debt issues are larger because large companies have the greatest access to public debt markets (small companies tend to borrow more from private lenders). Equity issuers are frequently small companies going public; such issues are often quite small. 2. (LO2) From the previous question, economies of scale are part of the answer. Beyond this, debt issues are simply easier and less risky to sell from an investment bank’s perspective. The two main reasons are that very large amounts of debt securities can be sold to a relatively small number of buyers, particularly large institutional buyers such as pension funds and insurance companies, and debt securities are much easier to price. 3. (LO2) They are riskier and harder to market from an investment bank’s perspective. 4. (LO2) Yields on comparable bonds can usually be readily observed, so pricing a bond issue accurately is much less difficult. 5. (LO3) It is clear that the stock was sold too cheaply, so Netscape had reason to be unhappy. 6. (LO3) No, but, in fairness, pricing the stock in such a situation is extremely difficult. 7. (LO3) It’s an important factor. Only 5 million of the shares were underpriced. The other 38 million were, in effect, priced completely correctly. 8. (LO4) The evidence suggests that a non-underwritten rights offering might be substantially cheaper than a cash offer. However, such offerings are rare, and there may be hidden costs or other factors not yet identified or well understood by researchers. 9. (LO3) He could have done worse since his access to the oversubscribed and, presumably, underpriced issues was restricted while the bulk of his funds were allocated to stocks from the undersubscribed and, quite possibly, overpriced issues. S15-1 Solutions to Questions and Problems NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. (LO4) a. The new market value will be the current shares outstanding times the stock price plus the rights offered times the rights price, so: New market value = 500,000($81) + 60,000($70) = $44,700,000 b. The number of rights associated with the old shares is the number of shares outstanding divided by the rights offered, so: Number of rights needed = 500,000 old shares/60,000 new shares = 8.33 rights per new share c. The new price of the stock will be the new market value of the company divided by the total number of shares outstanding after the rights offer, which will be: P X $44,700,000/(500,000 + 60,000) = $79.82 d. The value of the right Value of a right = $81.00 – 79.82 = $1.18 e. A rights offering usually costs less, it protects the proportionate interests of existing share-holders and also protects against underpricing. 2. (LO4) a. The maximum subscription price is the current stock price, or $53. The minimum price is anything greater than $0. b. The number of new shares will be the amount raised divided by the subscription price, so: Number of new shares = $40,000,000/$48 = 833,333 shares And the number of rights needed to buy one share will be the current shares outstanding divided by the number of new shares offered, so: Number of rights needed = 4,100,000 shares outstanding/833,333 new shares = 4.92 c. A shareholder can buy 4.92 rights on shares for: 4.92($53) = $260.76 The shareholder can exercise these rights for $48, at a total cost of: $260.76 + 48 = $308.76 The investor will then have: Ex-rights shares = 1 + 4.92 S15-2 Ex-rights shares = 5.92 The ex-rights price per share is: PX= [4.92($53) + $48]/5.92 = $52.16 So, the value of a right is: Value of a right = $53 – 52.16 = $0.84 d. Before the offer, a shareholder will have the shares owned at the current market price, or: Portfolio value = (1,000 shares)($53) = $53,000 After the rights offer, the share price will fall, but the shareholder will also hold the rights, so: Portfolio value = (1,000 shares)($52.16) + (1,000 rights)($0.84) = $53,000 3. (LO4) Using the equation we derived in Problem 2, part c to calculate the price of the stock ex-rights, we can find the number of shares a shareholder will have ex-rights, which is: PX= $74.80 = [N($81) + $40]/(N + 1) N = 5.613 The number of new shares is the amount raised divided by the per-share subscription price, so: Number of new shares = $20,000,000/$40 = 500,000 And the number of old shares is the number of new shares times the number of shares ex-rights, so: Number of old shares = 5.613(500,000) = 2,806,452 4. (LO3) If you receive 1,000 shares of each, the profit is: Profit = 1,000($7) – 1,000($5) = $2,000 Since you will only receive one-half of the shares of the oversubscribed issue, your profit will be: Expected profit = 500($7) – 1,000($5) = –$1,500 This is an example of the winner’s curse. 5. (LO3) Using X to stand for the required sale proceeds, the equation to calculate the total sale proceeds, including floatation costs is: X(1 – .09) = $60,000,000 X = $65,934,066 required total proceeds from sale. So the number of shares offered is the total amount raised divided by the offer price, which is: Number of shares offered = $65,934,066/$21 = 3,139,717 S15-3 6. (LO3) This is basically the same as the previous problem, except we need to include the $900,000 of expenses in the amount the company needs to raise, so: X(1 – .09) = ($60,000,000 + 900,000) X = $66,923,077 required total proceeds from sale. Number of shares offered = $66,923,077/$21 = 3,186,813 7. (LO3) We need to calculate the net amount raised and the costs associated with the offer. The net amount raised is the number of shares offered times the price received by the company, minus the costs associated with the offer, so: Net amount raised = (10,000,000 shares)($18.20) – 900,000 – 320,000 = $180,780,000 The company received $180,780,000 from the stock offering. Now we can calculate the direct costs. Part of the direct costs are given in the problem, but the company also had to pay the underwriters. The stock was offered at $20 per share, and the company received $18.20 per share. The difference, which is the underwriters spread, is also a direct cost. The total direct costs were: Total direct costs = $900,000 + ($20 – 18.20)(10,000,000 shares) = $18,900,000 We are given part of the indirect costs in the problem. Another indirect cost is the immediate price appreciation. The total indirect costs were: Total indirect costs = $320,000 + ($25.60 – 20)(10,000,000 shares) = $56,320,000 This makes the total costs: Total costs = $18,900,000 + 56,320,000 = $75,220,000 The floatation costs as a percentage of the amount raised is the total cost divided by the amount raised, so: Flotation cost percentage = $75,220,000/$180,780,000 = .4161 or 41.61% 8. (LO3) The number of rights needed per new share is: Number of rights needed = 120,000 old shares/25,000 new shares = 4.8 rights per new share. Using P RO as the rights-on price, and P Ss the subscription price, we can express the price per share of the stock ex-rights as: PX= [NP RO + PS]/(N + 1) a. PX= [4.8($94) + $94]/(4.80 + 1) = $94.00; No change. b. PX= [4.8($94) + $90]/(4.80 + 1) = $93.31; Price drops by $0.69 per share. c. PX= [4.8($94) + $85]/(4.80 + 1) = $92.45; Price drops by $1.55 p
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