Chapter 15 Raising Capital
Chapter 15 - Raising Capital
Chapter 15Raising Capital
Multiple Choice Questions
1.Jones & Co. is funded by a group of individual investors
for the sole purpose of providing funding for individuals who are
trying to convert their new ideas into viable products. What is
this type of funding called?A.green shoe fundingB.tombstone
underwritingC.venture capitalD.red herring fundingE.life cycle
capital
2.What is the form called that is filed with the SEC and
discloses the material information on a securities issuer when that
issuer offers new securities to the general
public?A.prospectusB.red herringC.indentureD.public disclosure
statementE.registration statement
3.Miller & Chase is offering $4 million of new securities to
the general public. Which SEC regulation governs this
offering?A.Regulation AB.Regulation CC.Regulation GD.Regulation
QE.Regulation R
4.What is a prospectus?A.a letter issued by the SEC authorizing
a new issue of securitiesB.a report stating that the SEC recommends
a new security to investorsC.a letter issued by the SEC that
outlines the changes required for a registration statement to be
approvedD.a document that describes the details of a proposed
security offering along with relevant information about the
issuerE.an advertisement in a financial newspaper that describes a
security offering
5.Which one of the following is a preliminary
prospectus?A.tombstoneB.green shoeC.registration statementD.rights
offerE.red herring
6.Advertisements in a financial newspaper announcing a public
offering of securities, along with a list of the investment banks
handling the offering, are called:A.red
herrings.B.tombstones.C.Green Shoes.D.registration
statements.E.cash offers.
7.What is an issue of securities that is offered for sale to the
general public on a direct cash basis called?A.best efforts
underwritingB.firm commitment underwritingC.general cash
offerD.rights offerE.herring offer
8.Tony currently owns 12,000 shares of GL Tools. He has just
been notified that the firm is issuing additional shares of stock
and that he is being given a chance to purchase some of these
shares prior to the shares being offered to the general public.
What is this type of an offer called?A.best efforts offerB.firm
commitment offerC.general cash offerD.rights offerE.priority
offer
9.Soup Galore is a partnership that was formed three years ago
for the purpose of creating, producing, and distributing healthy
soups in a dried form. The firm has been extremely successful thus
far and has decided to incorporate and offer shares of stock to the
general public. What is this type of an equity offering
called?A.venture capital offeringB.shelf offeringC.private
placementD.seasoned equity offeringE.initial public offering
10.What is a seasoned equity offering?A.an offering of shares by
shareholders for repurchase by the issuerB.shares of stock that
have been recommended for purchase by the SECC.equity securities
held by a firm's founder that are being offered for sale to the
general publicD.sale of newly issued equity shares by a firm that
is currently publicly ownedE.a set number of equity shares that are
issued and offered to the public annually
11.Executive Tours has decided to take its firm public and has
hired an investment firm to handle this offering. The investment
firm is serving as a(n):A.aftermarket specialist.B.venture
capitalist.C.underwriter.D.seasoned writer.E.primary investor.
12.What is the definition of a syndicate?A.a venture
capitalistB.a group of attorneys providing services for an
IPOC.block of investors who control a firmD.a bank that loans funds
to finance the start-up of a new firmE.a group of underwriters
sharing the risk of selling a new issue of securities
13.The difference between the underwriters' cost of buying
shares in a firm commitment and the offering price of those
securities to the public is called the:A.gross spread.B.under price
amountC.filing fee.D.new issue premium.E.offer price.
14.D.L. Jones & Co. recently went public. The firm received
$20.80 a share on the entire offer of 25,000 shares. Keeser &
Co. served as the underwriter and sold 23,700 shares to the public
at an offer price of $22 a share. What type of underwriting was
this?A.best effortsB.shelfC.over subscribedD.private
placementE.firm commitment
15.Blue Stone Builders recently offered to sell 45,000 newly
issued shares of stock to the public. The underwriters charged a
fee of 8 percent and paid Blue Stone Builders $16.40 a share on
40,000 shares. Which one of the following terms best describes this
underwriting?A.best effortsB.shelfC.direct rightsD.private
placementE.firm commitment
16.The 40-day period following an IPO during which the SEC
places restrictions on the public communications of the issuer is
known as the _____ period.A.silentB.quietC.lockupD.greenE.red
17.Denver Liquid Wholesalers recently offered 50,000 new shares
of stock for sale. The underwriters sold a total of 53,000 shares
to the public. The additional 3,000 shares were purchased in
accordance with which one of the following?A.Green shoe
provisionB.Red herring provisionC.quiet provisionD.lockup
agreementE.post-issue agreement
18.Shares of PLS United have been selling with rights attached.
Tomorrow, the stock will sell independent of these rights. Which
one of the following terms applies to tomorrow in relation to this
stock?A.pre-issue dateB.aftermarket dateC.declaration
dateD.holder-of-record dateE.ex-rights date
19.The date on which a shareholder is officially listed as the
recipient of stock rights is called the:A.issue date.B.offer
dateC.declaration dateD.holder-of-record date.E.ex-rights date.
20.A rights offering in which an underwriting syndicate agrees
to purchase the unsubscribed portion of an issue is called a _____
underwriting.A.standbyB.best effortsC.firm commitmentD.direct
feeE.tombstone
21.The amount paid to an underwriter who participates in a
standby underwriting agreement is called a(n):A.gross
spread.B.optional spread.C.standby fee.D.additional
fee.E.oversubscription fee.
22.Franklin Minerals recently had a rights offering of 1,000
shares at an offer price of $10 a share. Isabelle is a shareholder
who exercised her rights option by buying all of the rights to
which she was entitled based on the number of shares she owns.
Currently, there are six shareholders who have opted not to
participate in the rights offering. Isabelle would like to purchase
the unsubscribed shares. Which one of the following will allow her
to do so?A.standby provisionB.oversubscription privilegeC.open
offer privilegeD.new issues provisionE.overallotment provision
23.Roy owns 200 shares of R.T.F., Inc. He has opted not to
participate in the current rights offering by this firm. As a
result, Roy will most likely be subject to:A.an oversubscription
cost.B.underpricing.C.dilution.D.the Green Shoe provision.E.a
locked in period.
24.Direct business loans typically ranging from one to five
years are called:A.private placements.B.debt SEOs.C.notes
payable.D.debt IPOs.E.term loans.
25.A group of five private investors recently loaned $6 million
to Henderson Hardware for ten years at 9 percent interest. This
loan is best described as a:A.private placement.B.debt SEO.C.notes
payable.D.debt IPO.E.term loan.
26.Pearson Electric recently registered 250,000 shares of stock
under SEC Rule 415. The firm plans to sell 150,000 shares this year
and the remaining 100,000 shares next year. What type of
registration was this?A.standby registrationB.shelf
registrationC.Regulation A registrationD.Regulation Q
registrationE.private placement registration
27.Suzie is a chemist who has been experimenting with fragrances
in her home laboratory and feels that she now has three viable
perfumes that could be successfully marketed. She knows a venture
capitalist who has offered to finance her business to the point
where she would be ready to begin the manufacturing and marketing
stage. Which type of financing is Suzie being
offered?A.syndicateB.introductionC.second-stageD.mezzanine-levelE.seed
money
28.Which one of the following is probably the most successful
means of finding venture capital?A.internet searchesB.Dutch
auctionsC.newspaper advertisementsD.personal contactsE.personal
letters to venture capital firms
29.Which one of the following statements concerning venture
capital financing is correct?A.Venture capitalists desire shares of
common stock but avoid preferred stock.B.Venture capital is
relatively easy to obtain.C.Venture capitalists rarely assume
active roles in the management of the financed firm.D.Venture
capitalists often require at least a forty percent equity position
as a condition of financing.E.Venture capital is relatively
inexpensive in today's competitive markets.
30.Which one of the following statements concerning venture
capitalists is correct?A.Venture capitalists assume management
responsibility for the firms they finance.B.Exit strategy is a key
consideration when selecting a venture capitalist.C.Venture
capitalists limit their services to providing money to start-up
firms.D.Most venture capitalists are long-term investors in a
firm.E.A venture capitalist normally invests in a new idea and
finances that idea until the newly-formed firm can issue an
IPO.
31.Which of the following should be considered when selecting a
venture capitalist?I. level of involvementII. past experiencesIII.
termination of fundingIV. financial strengthA.I and III onlyB.II
and IV onlyC.I, III, and IV onlyD.I, II, and IV onlyE.I, II, III,
and IV
32.Trevor is the CEO of Harvest Foods, which is a privately-held
corporation. What is the first step he must take if he wishes to
take Harvest Foods public?A.select an underwriterB.obtain SEC
approvalC.gain board approvalD.prepare a registration
statementE.distribute a prospectus
33.All new interstate security issues are regulated by
the:A.registration statement.B.Green Shoe provision.C.Securities
Exchange Act of 1934.D.Securities Act of 1933.E.Federal Reserve Act
of 1931.
34.The Securities and Exchange Commission:A.verifies the
accuracy of the information contained in the prospectus.B.verifies
the accuracy of the information contained in the red
herring.C.examines the registration statement during the Green Shoe
period.D.is concerned only that an issue complies with all rules
and regulations.E.determines the final offer price once they have
approved the registration statement.
35.Underwriters generally:A.pay a spread to the issuing
firm.B.provide only best efforts underwriting in the U.S.C.receive
less compensation under a competitive agreement than under a
negotiated agreement.D.market and distribute an entire issue of new
securities within their own firm.E.pass the risk of unsold shares
back to the issuing firm via a firm commitment agreement.
36.With firm commitment underwriting, the issuing firm:A.is
unsure of the total amount of funds it will receive until after the
offering is completed.B.is unsure of the number of shares it will
actually issue until after the offering is completed.C.knows
exactly how many shares will be purchased by the general public
during the offer period.D.retains the financial risk associated
with unsold shares.E.knows up-front the amount of money it will
receive from the stock offering.
37.With Dutch auction underwriting:A.each winning bidder pays
the price he or she bid.B.all successful bidders pay the same
price.C.all bidders receive at least a portion of the quantity for
which they bid.D.the selling firm receives the maximum possible
price for each security sold.E.the bidder for the largest quantity
receives the first allocation of securities.
38.If an IPO is underpriced then the:A.investors in the IPO are
generally unhappy with the underwriters.B.issue is less likely to
sell out.C.stock price will generally decline on the first day of
trading.D.issuing firm is guaranteed to be successful in the long
term.E.issuing firm receives less money than it probably should
have.
39.Which of the following have been offered as supporting
arguments in favor of IPO underpricing?I. Underpricing counteracts
the "winner's curse".II. Underpricing rewards institutional
investors for sharing their opinions of a stock's market value.III.
Underpricing diminishes the underwriting risk of a firm commitment
underwriting.IV. Underpricing reduces the probability that
investors will sue the underwriters.A.I and III onlyB.II and IV
onlyC.I and II onlyD.I, II, and III onlyE.I, II, III, and IV
40.Which one of the following is a key goal of the aftermarket
period?A.collection of largest number of Dutch auction bids as
possibleB.best determination of a fair offer price for an upcoming
IPOC.price support for a new issue of securitiesD.establishment of
a broad-based underwriting syndicate for an upcoming IPOE.widest
distribution of red herrings as possible
41.Which one of the following statements is correct?A.The quiet
period commences when a registration statement is filed with the
SEC and ends on the day the IPO shares commence trading.B.Lockup
agreements outline how oversubscribed IPO shares will be
allocated.C.Additional IPO shares can be issued in accordance with
the lockup agreement.D.Quiet period restrictions only apply to the
issuer of new securities.E.A TV interview with a firm's CFO could
cause a forced delay in the firm's IPO.
42.An individual investor with a small portfolio who wishes to
purchase 100 shares of each IPO is more likely to receive an
allocation of shares when:A.an IPO is substantially oversubscribed
than when it is not.B.the knowledgeable investors feel the issue is
underpriced.C.an IPO is severely underpriced.D.an IPO is
undersubscribed.E.he or she has a standing order with the
underwriter to purchase shares in every IPO handled by that
underwriter.
43.When a firm announces an upcoming seasoned stock offering,
the market price of the firm's existing shares tends
to:A.increase.B.decrease.C.remain constant.D.respond but the
direction of the response is not predictable as shown by past
studies.E.decrease momentarily and then immediately increase
substantially within an hour following the announcement.
44.The total direct costs of underwriting an equity IPO:A.tends
to increase on a percentage basis as the proceeds of the IPO
increase.B.is generally between 7 and 8 percent, regardless of the
issue size.C.can be as high as 25 percent for small
issues.D.excludes the gross spread.E.excludes both the gross spread
and the underpricing cost.
45.Which one of the following statements is correct concerning
the costs of issuing securities?A.Domestic bonds are generally more
expensive to issue than equity IPOs.B.Abnormal returns are rarely
associated with seasoned issues.C.A seasoned offering is typically
more expensive on a percentage basis than an IPO.D.There tends to
be substantial economies of scale when issuing securities.E.The
costs of issuing convertible bonds tend to be less on a percentage
basis than the costs of issuing straight debt.
46.Existing shareholders:A.may or may not have a preemptive
right to newly issued shares.B.must purchase new shares whenever
rights are issued.C.are prohibited from selling their rights.D.are
generally well advised to let the rights they receive expire.E.can
maintain their proportional ownership positions without exercising
their rights.
47.To purchase shares in a rights offering, a shareholder
generally just needs to:A.pay the subscription amount in
cash.B.submit the required form along with the required number of
rights.C.pay the difference between the market price of the stock
and the subscription price.D.submit the required number of rights
along with a payment for the underwriting fee.E.submit the required
number of rights along with the subscription price.
48.The value of a right depends upon:I. the number of rights
required to purchase one new share.II. the market price of the
security.III. the subscription price.IV. the price-earnings ratio
of the stock.A.II and III onlyB.II and IV onlyC.I and II onlyD.I,
II, and III onlyE.I, II, III, and IV
49.Before a seasoned stock offering, you owned 7,500 shares of a
firm that had 500,000 shares outstanding. After the seasoned
offering, you still owned 7,500 shares but the number of shares
outstanding rose to 625,000. Which one of the following terms best
describes this situation?A.overallotmentB.percentage ownership
dilutionC.Green ShoeD.Red herringE.abnormal event
50.Which one of the following statements concerning dilution is
correct?A.Dilution of percentage ownership occurs whenever an
investor participates in a rights offer.B.Market value dilution
increases as the net present value of a project increases.C.Market
value dilution occurs when the net present value of a project is
negative.D.Neither book value dilution nor market value dilution
has any direct bearing on individual shareholders.E.Book value
dilution is the cause of market value dilution.
51.Which one of the following statements is correct concerning
the issuance of long-term debt?A.A direct long-term loan has to be
registered with the SEC.B.Direct placement debt tends to have more
restrictive covenants than publicly issued debt.C.Distribution
costs are lower for public debt than for private debt.D.It is
easier to renegotiate public debt than private debt.E.Wealthy
individuals tend to dominate the private debt market.
52.Shelf registration allows a firm to register multiple issues
at one time with the SEC and then sell those registered shares
anytime during the subsequent:A.3 months.B.6 months.C.180 days.D.2
years.E.5 years.
53.Aaron's Sailboats has decided to take the company public by
offering a total of 120,000 shares of common stock to the public.
The firm has hired an underwriter who arranges a full commitment
underwriting and suggests an initial selling price of $28 a share
with an 8.5 percent spread. As it turns out, the underwriters only
sell 97,400 shares. How much cash will Aaron's Sailboats receive
from its first public
offering?A.$2,727,200B.$2,495,388C.$3,074,400D.$3,360,000E.$3,645,600
54.Nelson Paints recently went public by offering 65,000 shares
of common stock to the public. The underwriters provided their
services in a best efforts underwriting. The offering price was set
at $16 a share and the gross spread was $2. After completing their
sales efforts, the underwriters determined that they sold a total
of 57,500 shares. How much cash did Nelson Paints receive from its
IPO?A.$805,000B.$910,000C.$920,000D.$1,035,000E.$1,040,000
55.Miller Motors has decided to sell 1,600 shares of stock
through a Dutch auction. The bids received are as follows:
How much will Miller Motors receive in total from selling the
1,600 shares? Ignore all transaction and flotation
costs.A.$30,400B.$33,400C.$33,600D.$35,400E.$38,600
56.Bakers' Town Bread is selling 1,200 shares of stock through a
Dutch auction. The bids received are as follows:
How much cash will Bakers' Town Bread receive from selling these
shares of stock? Ignore all transaction and flotation
costs.A.$10,800B.$12,000C.$13,400D.$14,400E.$16,800
57.Webster Electrics is offering 1,500 shares of stock in a
Dutch auction. The bids include:
How much cash will Webster Electrics receive from selling these
shares? Ignore all transaction and flotation
costs.A.$28,500B.$30,000C.$31,500D.$33,000E.$34,500
58.You are a broker and have been instructed to place an order
for a client to purchase 500 shares of every IPO that comes to
market. The next two IPOs are each priced at $25 a share and will
begin trading on the same day. The client is allocated 500 shares
of IPO A and 100 shares of IPO B. At the end of the first day of
trading, IPO A was selling for $23.50 a share and IPO B was selling
for $29 a share. What is the client's total profit or loss on these
two IPOs as of the end of the first day of
trading?A.-$425B.-$350C.$525D.$975E.$1,150
59.Richard has an outstanding order with his stock broker to
purchase 1,000 shares of every IPO. The next three IPOs are each
priced at $30 a share and will all start trading on the same day.
Richard is allocated 1,000 shares of IPO A, 400 shares of IPO B,
and 100 shares of IPO C. On the first day of trading IPO A opened
at $31.50 a share and ended the day at $26 a share. IPO B opened at
$31 a share and finished the day at $32 a share. IPO C opened at
$36.50 a share and ended the day at $40.25 a share. What is
Richard's total profit or loss on these three IPOs as of the end of
the first day of
trading?A.-$2,175B.-$1,850C.-$1,500D.$2,250E.$3,500
60.Two IPOs will commence trading next week. Scott places an
order to buy 300 shares of IPO A. Steve places an order to purchase
300 shares of IPO A and 300 shares of IPO B. Both IPOs are priced
at $20 a share. Scott is allocated 100 shares of IPO A. Steve is
allocated 100 shares of IPO A and 300 shares of IPO B. At the end
of the first day of trading, IPO A is selling for $22.70 a share
and IPO B is selling for $18.60 a share. What is the difference in
the total profits or losses that Scott and Steve have as of the end
of the first day of trading?A.$120B.$240C.$360D.$420E.$580
61.Wear Ever is expanding and needs $12.6 million to help fund
this growth. The firm estimates it can sell new shares of stock for
$32.50 a share. It also estimates it will cost an additional
$340,000 for filing and legal fees related to the stock issue. The
underwriters have agreed to a 7.5 percent spread. How many shares
of stock must Wear Ever sell if it is going to have $12.6 million
available for its expansion needs?A.370,376 sharesB.419,127
sharesC.430,437 sharesD.454,209 sharesE.461,806 shares
62.Mountain Teas wants to raise $11.6 million to open a new
production center. The company estimates the issue costs including
the legal and accounting fees will be $440,000. The underwriters
have set the stock price at $17.50 a share and the underwriting
spread at 9 percent. How many shares of stock does Mountain Teas
have to sell to meet its cash need?A.728,414 sharesB.756,044
sharesC.769,315 sharesD.772,200 sharesE.781,909 shares
63.Outdoor Living needs $7.5 million to finance modifications to
its production equipment because the design of its all-season tents
has changed dramatically. The underwriters estimate that the firm
could sell additional shares of stock at $14.50 a share with a 7.5
percent underwriting spread. This would be a firm commitment
underwriting. The estimated issue costs are $121,000. How many
shares of stock will Outdoor Living need to sell to finance this
project?A.568,201 sharesB.488,917 sharesC.452,311 sharesD.559,180
sharesE.562,400 shares
64.High Mountain Mining wants to expand its current operations
and requires $3.5 million in additional funding to do so. After
discussing this with key shareholders, the firm has decided to
raise the necessary funds through a rights offering at a
subscription price of $18 a share. The current market price of the
firm's stock is $22 a share. How many shares of stock will the firm
need to sell through the rights offering to fund the expansion
plans?A.140,015 sharesB.159,091 sharesC.166,667 sharesD.194,444
sharesE.205,688 shares
65.Northwest Rail wants to raise $14.2 million through a rights
offering so it can purchase additional rail cars and upgrade its
maintenance facilities. How many shares of stock will the firm need
to sell through this offering if the current market price is $34 a
share and the subscription price is $28 a share?A.417,647
sharesB.437,856 sharesC.458,065 sharesD.482,604 sharesE.507,143
shares
66.A.K. Stevenson wants to raise $7.5 million through a rights
offering. The subscription price is set at $24. Currently, the
company has 2.1 million shares outstanding with a current market
price of $25 a share. Each shareholder will receive one right for
each share of stock they currently own. How many rights will be
needed to purchase one new share of stock in this offering?A.6.40
rightsB.6.67 rightsC.6.72 rightsD.6.87 rightsE.7.00 rights
67.The Motor Plant wants to raise $21.4 million through a rights
offering so it can modernize its facilities. The subscription price
for the offering is set at $12 a share. Currently, the company has
2.6 million shares of stock outstanding at a market price of $12.50
a share. Each shareholder will receive one right for each share of
stock they own. How many rights will a shareholder need to purchase
one new share of stock in this offering?A.1.46 rightsB.1.52
rightsC.1.55 rightsD.1.60 rightsE.1.67 rights
68.Miller Fruit wants to expand its citrus grove operations. The
firm estimates that it needs $8.6 million to buy land and establish
its operations. Currently, the firm has 540,000 shares of stock
outstanding at a market price per share of $34.80. If the firm
decides to raise the needed capital through a rights offering, one
right will be issued for each share of stock. The subscription
price will be set at $33 a share. How many rights will a
shareholder need to purchase one new share of stock in this
offering?A.2.07 rightsB.2.17 rightsC.2.22 rightsD.2.50 rightsE.2.67
rights
69.Jefferson Refining is issuing a rights offering wherein every
shareholder will receive one right for each share of stock they
own. The new shares in this offering are priced at $21 plus 3
rights. The current market price of the stock is $23 a share. What
is the value of one right?A.$0.25B.$0.50C.$1.00D.$1.50E.$2.00
70.The stock of Cleaner Home Products is currently selling for
$26.40 a share. The company has decided to raise funds through a
rights offering wherein every shareholder will receive one right
for each share of stock they own. The new shares being offered are
priced at $25 plus five rights. What is the value of one
right?A.$0.16B.$0.23C.$0.25D.$0.47E.$0.50
71.Barstow Industrial Supply has decided to raise $27.52 million
in additional funding via a rights offering. The firm will issue
one right for each share of stock outstanding. The offering
consists of a total of 860,000 new shares. The current market price
of the stock is $35. Currently, there are 5.16 million shares
outstanding. What is the value of one
right?A.$0.37B.$0.43C.$0.48D.$0.52E.$0.60
72.You currently own 8 percent of the 3.5 million outstanding
shares of Webster Mills. The company has just announced a rights
offering with a subscription price of $28. One right will be issued
for each share of outstanding stock. This offering will provided $9
million of new financing for the firm, ignoring all issue costs.
Assume that all rights are exercised. What will be your new
ownership position if you opted to sell your rights rather than
exercise them personally?A.7.33 percentB.7.46 percentC.7.87
percentD.8.00 percentE.8.21 percent
73.Jennifer owns 12,000 shares of Calico Clothing. Currently,
there are 1.6 million shares of stock outstanding. The company has
just announced a rights offering whereby 200,000 shares are being
offered for sale at a subscription price of $14 a share. The
current stock price is $16 a share. Assume that Jennifer sells her
rights and that all rights are exercised. What percentage of the
firm will Jennifer own after the rights offering?A.0.67
percentB.0.75 percentC.0.86 percentD.0.93 percentE.1.01 percent
74.Underwater Experimental is considering a project which
requires the purchase of $498,000 of fixed assets. The net present
value of the project is $22,500. Equity shares will be issued as
the sole means of financing the project. What will the new book
value per share be after the project is implemented given the
following current information on the firm?
A.$13.25B.$13.70C.$14.23D.$14.94E.$15.60
75.Birds and More is considering a project which requires the
purchase of $164,000 of fixed assets. The net present value of the
project is $4,500. Equity shares will be issued as the sole means
of financing this project. The price-earnings ratio of the project
equals that of the existing firm. What will the new market value
per share be after the project is implemented given the following
current information on the firm?
A.$20.68B.$20.72C.$20.80D.$20.95E.$21.10
76.Wagner Trucking is considering investing in a new project
that will cost $13 million and increase net income by 6.5 percent.
This project will be completely funded by issuing new equity
shares. Currently, the firm has 1.25 million shares of stock
outstanding with a market price of $42 per share. The current
earnings per share are $1.82. What will the earnings per share be
if the project is
implemented?A.$1.39B.$1.45C.$1.55D.$1.62E.$1.69
77.You own 15 percent or 13,500 shares of Printers, Etc. These
shares have a total market value of $426,600. By what percentage
will the total value of your investment in this firm change if the
company sells an additional 10,000 shares of stock at $30 a share
and you do not buy any?A.-1.37 percentB.-1.21 percentC.-0.51
percentD.1.03 percentE.1.29 percent
78.Kurt currently owns 3.4 percent of Northeastern
Transportation. The company has a total of 438,000 shares
outstanding with a current market price of $26.20 a share. At
present, the firm is offering an additional 25,000 shares at a
price of $25 a share. Kurt decides not to participate in this
offering. What will his ownership position be after the offering is
completed?A.3.06 percentB.3.22 percentC.3.27 percentD.3.40
percentE.3.51 percent
Essay Questions
79.It can be argued that the decision to accept venture capital
is one of the most critical decisions an entrepreneur must make.
Explain why.
80.Explain both a rights offering and the basic characteristics
of a right.
81.Explain why there is a tendency for IPOs to be
underpriced.
82.Firms encounter several costs when issuing new securities.
Identify and describe at least four of these costs.
83.Steve is the founder of Jefferson & Westover. Recently,
the firm decided to issue an IPO with Steve retaining 30 percent
ownership of the firm. The IPO agreement contained both a Green
Shoe provision and a 6-month lockup agreement. Steve's cost basis
per share is $15. The offering price for the IPO was $16. On the
first day of trading, the market price per share rose to $28.20 and
closed for the day at $25.60. Now, six months after the IPO
release, the stock is valued at $15.40 a share. Explain who
benefited the most during the lockup period, an outside investor or
Steve, and why.
Multiple Choice Questions
84.The Timken Company has announced a rights offer to raise $25
million for a new journal, the Journal of Financial Excess. This
journal will review potential articles after the author pays a
nonrefundable reviewing fee of $2,500 per page. The stock currently
sells for $48 per share, and there are 2.6 million shares
outstanding. The subscription price is set at $43 per share. What
is the ex-rights price per
share?A.$45.58B.$47.09C.$48.15D.$48.80E.$49.42
85.The Warm Shoe Co. has concluded that additional equity
financing will be needed to expand operations and that the needed
funds will be best obtained through a rights offering. It has
correctly determined that as a result of the rights offering, the
share price will fall from $100 to $95 ($100 is the
rights-on-price; $95 is the ex-rights price, also known as the
when-issued price). The company is seeking $18 million in
additional funds with a per-share subscription price of $50. How
many shares of stock are outstanding, before the offering? (Assume
that the increment to the market value of the equity equals the
gross proceeds of the
offering.)A.324,000B.360,000C.1,800,000D.3,240,000E.3,600,000
86.The Woods Co. and the Mickelson Co. have both announced IPOs
at $43 per share. One of these is undervalued by $20, and the over
is overvalued by $14, but you have no way of knowing which is
which. You plan on buying 1,000 shares of each issue. If an issue
is underpriced, it will be rationed, and only half your order will
be filled. What is the amount of the difference between your
expected profit and the amount of profit you could earn if you
could get 1,000 shares of Woods and 1,000 shares of
Mickelson?A.-$10,000B.-$6,000C.-$4,000D.$4,000E.$6,000
87.Flagler, Inc. needs to raise $30 million to finance its
expansion into new markets. The company will sell new shares of
equity via a general cash offering to raise the needed funds. The
offer price is $30 per share and the company's underwriters charge
a 10 percent spread. How many shares need to be sold?A.1,111,111
sharesB.1,250,000 sharesC.1,666,667 sharesD.2,500,000
sharesE.3,333,333 shares
88.The Educated Horses Corporation needs to raise $20 million to
finance its expansion into new markets. The company will sell new
shares of equity via a general cash offering to raise the needed
funds. Suppose the offer price is $40 per share and the company's
underwriters charge an 8 percent spread. The SEC filing fee and
associated administrative expenses of the offering are $660,000.
How many shares need to be
sold?A.448,907B.461,222C.511,111D.529,937E.561,413
89.The Huff Co. has just gone public. Under a firm commitment
agreement, Huff received $21.50 for each of the 6 million shares
sold. The initial offering price was $23.65 per share, and the
stock rose to $30.51 per share in the first few minutes of trading.
Huff paid $1,260,000 in direct legal and other costs, and $390,000
in indirect costs. The flotation costs were what percentage of the
funds raised?A.38.56 percentB.40.32 percentC.41.68 percentD.43.75
percentE.44.09 percent
90.Mountain Homes wishes to expand its facilities. The company
currently has 7 million shares outstanding and no debt. The stock
sells for $55 per share, but the book value per share is $43. The
firm's net income is currently $9.1 million. The new facility will
cost $30 million, and it will increase net income by $309,000.
Assume the firm issues new equity to fund this expansion while
maintaining a constant price-earnings ratio. What will be the EPS
be after the new equity
issue?A.$1.25B.$1.30C.$1.35D.$1.40E.$1.45
91.The Metallica Heavy Metal Mining (MHMM) Corporation wants to
diversify its operations. Some recent financial information for the
company is shown here:
MHMM is considering an investment that has the same P/E ratio as
the firm. The cost of the investment is $798,270, and it will be
financed with a new equity issue. What would the ROE on the
investment have to be if we wanted the price after the offering to
be $110 per share? Assume the PE ratio remains constant.A.18.28
percentB.21.41 percentC.27.63 percentD.37.27 percentE.40.03
percent
92.Precise Machining is considering a rights offer. The company
has determined that the ex-rights price would be $46. The current
price is $53 per share, and there are 7 million shares outstanding.
The rights offer would raise a total of $70 million. What is the
subscription price?A.$26.48B.$27.06C.$27.50D.$28.18E.$29.10
93.Atlas Corp. wants to raise $4 million via a rights offering.
The company currently has 450,000 shares of common stock
outstanding that sell for $40 per share. Its underwriter has set a
subscription price of $26 per share and will charge the company a 7
percent spread. Assume that you currently own 7,200 shares of stock
in the company and decide not to participate in the rights
offering. How much can you get for selling all of your
rights?A.$24,911.21B.$25,362.84C.$25,792.19D.$26,414.14E.$27,094.95
Chapter 15 Raising Capital Answer Key
Multiple Choice Questions
1.Jones & Co. is funded by a group of individual investors
for the sole purpose of providing funding for individuals who are
trying to convert their new ideas into viable products. What is
this type of funding called?A.green shoe fundingB.tombstone
underwritingC.venture capitalD.red herring fundingE.life cycle
capital
Refer to section 15.1
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-1Section: 15.1Topic: Venture capital2.What is the form called
that is filed with the SEC and discloses the material information
on a securities issuer when that issuer offers new securities to
the general public?A.prospectusB.red herringC.indentureD.public
disclosure statementE.registration statement
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: Registration statement3.Miller & Chase
is offering $4 million of new securities to the general public.
Which SEC regulation governs this offering?A.Regulation
AB.Regulation CC.Regulation GD.Regulation QE.Regulation R
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: Regulation A4.What is a prospectus?A.a
letter issued by the SEC authorizing a new issue of securitiesB.a
report stating that the SEC recommends a new security to
investorsC.a letter issued by the SEC that outlines the changes
required for a registration statement to be approvedD.a document
that describes the details of a proposed security offering along
with relevant information about the issuerE.an advertisement in a
financial newspaper that describes a security offering
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: Prospectus5.Which one of the following is a
preliminary prospectus?A.tombstoneB.green shoeC.registration
statementD.rights offerE.red herring
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: Red herring6.Advertisements in a financial
newspaper announcing a public offering of securities, along with a
list of the investment banks handling the offering, are
called:A.red herrings.B.tombstones.C.Green Shoes.D.registration
statements.E.cash offers.
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: Tombstones7.What is an issue of securities
that is offered for sale to the general public on a direct cash
basis called?A.best efforts underwritingB.firm commitment
underwritingC.general cash offerD.rights offerE.herring offer
Refer to section 15.3
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.3Topic: General cash offer8.Tony currently owns
12,000 shares of GL Tools. He has just been notified that the firm
is issuing additional shares of stock and that he is being given a
chance to purchase some of these shares prior to the shares being
offered to the general public. What is this type of an offer
called?A.best efforts offerB.firm commitment offerC.general cash
offerD.rights offerE.priority offer
Refer to section 15.3
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.3Topic: Rights offer9.Soup Galore is a partnership
that was formed three years ago for the purpose of creating,
producing, and distributing healthy soups in a dried form. The firm
has been extremely successful thus far and has decided to
incorporate and offer shares of stock to the general public. What
is this type of an equity offering called?A.venture capital
offeringB.shelf offeringC.private placementD.seasoned equity
offeringE.initial public offering
Refer to section 15.3
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-3Section: 15.3Topic: Initial public offering10.What is a
seasoned equity offering?A.an offering of shares by shareholders
for repurchase by the issuerB.shares of stock that have been
recommended for purchase by the SECC.equity securities held by a
firm's founder that are being offered for sale to the general
publicD.sale of newly issued equity shares by a firm that is
currently publicly ownedE.a set number of equity shares that are
issued and offered to the public annually
Refer to section 15.3
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.3Topic: Seasoned equity offering11.Executive Tours
has decided to take its firm public and has hired an investment
firm to handle this offering. The investment firm is serving as
a(n):A.aftermarket specialist.B.venture
capitalist.C.underwriter.D.seasoned writer.E.primary investor.
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Underwriters12.What is the definition of a
syndicate?A.a venture capitalistB.a group of attorneys providing
services for an IPOC.block of investors who control a firmD.a bank
that loans funds to finance the start-up of a new firmE.a group of
underwriters sharing the risk of selling a new issue of
securities
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Syndicate13.The difference between the
underwriters' cost of buying shares in a firm commitment and the
offering price of those securities to the public is called
the:A.gross spread.B.under price amountC.filing fee.D.new issue
premium.E.offer price.
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Gross spread14.D.L. Jones & Co.
recently went public. The firm received $20.80 a share on the
entire offer of 25,000 shares. Keeser & Co. served as the
underwriter and sold 23,700 shares to the public at an offer price
of $22 a share. What type of underwriting was this?A.best
effortsB.shelfC.over subscribedD.private placementE.firm
commitment
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Firm commitment15.Blue Stone Builders
recently offered to sell 45,000 newly issued shares of stock to the
public. The underwriters charged a fee of 8 percent and paid Blue
Stone Builders $16.40 a share on 40,000 shares. Which one of the
following terms best describes this underwriting?A.best
effortsB.shelfC.direct rightsD.private placementE.firm
commitment
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Best efforts16.The 40-day period following
an IPO during which the SEC places restrictions on the public
communications of the issuer is known as the _____
period.A.silentB.quietC.lockupD.greenE.red
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Quiet period17.Denver Liquid Wholesalers
recently offered 50,000 new shares of stock for sale. The
underwriters sold a total of 53,000 shares to the public. The
additional 3,000 shares were purchased in accordance with which one
of the following?A.Green shoe provisionB.Red herring
provisionC.quiet provisionD.lockup agreementE.post-issue
agreement
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Green shoe provision18.Shares of PLS United
have been selling with rights attached. Tomorrow, the stock will
sell independent of these rights. Which one of the following terms
applies to tomorrow in relation to this stock?A.pre-issue
dateB.aftermarket dateC.declaration dateD.holder-of-record
dateE.ex-rights date
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Ex-rights date19.The date on which a
shareholder is officially listed as the recipient of stock rights
is called the:A.issue date.B.offer dateC.declaration
dateD.holder-of-record date.E.ex-rights date.
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Holder-of-record date20.A rights offering
in which an underwriting syndicate agrees to purchase the
unsubscribed portion of an issue is called a _____
underwriting.A.standbyB.best effortsC.firm commitmentD.direct
feeE.tombstone
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Standby underwriting21.The amount paid to
an underwriter who participates in a standby underwriting agreement
is called a(n):A.gross spread.B.optional spread.C.standby
fee.D.additional fee.E.oversubscription fee.
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Standby fee22.Franklin Minerals recently
had a rights offering of 1,000 shares at an offer price of $10 a
share. Isabelle is a shareholder who exercised her rights option by
buying all of the rights to which she was entitled based on the
number of shares she owns. Currently, there are six shareholders
who have opted not to participate in the rights offering. Isabelle
would like to purchase the unsubscribed shares. Which one of the
following will allow her to do so?A.standby
provisionB.oversubscription privilegeC.open offer privilegeD.new
issues provisionE.overallotment provision
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Oversubscription privilege23.Roy owns 200
shares of R.T.F., Inc. He has opted not to participate in the
current rights offering by this firm. As a result, Roy will most
likely be subject to:A.an oversubscription
cost.B.underpricing.C.dilution.D.the Green Shoe provision.E.a
locked in period.
Refer to section 15.9
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.9Topic: Dilution24.Direct business loans typically
ranging from one to five years are called:A.private
placements.B.debt SEOs.C.notes payable.D.debt IPOs.E.term
loans.
Refer to section 15.10
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.10Topic: Term loans25.A group of five private
investors recently loaned $6 million to Henderson Hardware for ten
years at 9 percent interest. This loan is best described as
a:A.private placement.B.debt SEO.C.notes payable.D.debt IPO.E.term
loan.
Refer to section 15.10
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.10Topic: Private placement26.Pearson Electric
recently registered 250,000 shares of stock under SEC Rule 415. The
firm plans to sell 150,000 shares this year and the remaining
100,000 shares next year. What type of registration was
this?A.standby registrationB.shelf registrationC.Regulation A
registrationD.Regulation Q registrationE.private placement
registration
Refer to section 15.11
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.11Topic: Shelf registration27.Suzie is a chemist
who has been experimenting with fragrances in her home laboratory
and feels that she now has three viable perfumes that could be
successfully marketed. She knows a venture capitalist who has
offered to finance her business to the point where she would be
ready to begin the manufacturing and marketing stage. Which type of
financing is Suzie being
offered?A.syndicateB.introductionC.second-stageD.mezzanine-levelE.seed
money
Refer to section 15.1
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-1Section: 15.1Topic: Seed money28.Which one of the following is
probably the most successful means of finding venture
capital?A.internet searchesB.Dutch auctionsC.newspaper
advertisementsD.personal contactsE.personal letters to venture
capital firms
Refer to section 15.1
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-1Section: 15.1Topic: Venture capital29.Which one of the
following statements concerning venture capital financing is
correct?A.Venture capitalists desire shares of common stock but
avoid preferred stock.B.Venture capital is relatively easy to
obtain.C.Venture capitalists rarely assume active roles in the
management of the financed firm.D.Venture capitalists often require
at least a forty percent equity position as a condition of
financing.E.Venture capital is relatively inexpensive in today's
competitive markets.
Refer to section 15.1
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-1Section: 15.1Topic: Venture capital30.Which one of the
following statements concerning venture capitalists is
correct?A.Venture capitalists assume management responsibility for
the firms they finance.B.Exit strategy is a key consideration when
selecting a venture capitalist.C.Venture capitalists limit their
services to providing money to start-up firms.D.Most venture
capitalists are long-term investors in a firm.E.A venture
capitalist normally invests in a new idea and finances that idea
until the newly-formed firm can issue an IPO.
Refer to section 15.1
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-1Section: 15.1Topic: Venture capital31.Which of the following
should be considered when selecting a venture capitalist?I. level
of involvementII. past experiencesIII. termination of fundingIV.
financial strengthA.I and III onlyB.II and IV onlyC.I, III, and IV
onlyD.I, II, and IV onlyE.I, II, III, and IV
Refer to section 15.1
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-1Section: 15.1Topic: Venture capital32.Trevor is the CEO of
Harvest Foods, which is a privately-held corporation. What is the
first step he must take if he wishes to take Harvest Foods
public?A.select an underwriterB.obtain SEC approvalC.gain board
approvalD.prepare a registration statementE.distribute a
prospectus
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2 and 15-3Section: 15.2Topic: IPO33.All new interstate security
issues are regulated by the:A.registration statement.B.Green Shoe
provision.C.Securities Exchange Act of 1934.D.Securities Act of
1933.E.Federal Reserve Act of 1931.
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: Securities Act of 193334.The Securities and
Exchange Commission:A.verifies the accuracy of the information
contained in the prospectus.B.verifies the accuracy of the
information contained in the red herring.C.examines the
registration statement during the Green Shoe period.D.is concerned
only that an issue complies with all rules and
regulations.E.determines the final offer price once they have
approved the registration statement.
Refer to section 15.2
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.2Topic: SEC35.Underwriters generally:A.pay a spread
to the issuing firm.B.provide only best efforts underwriting in the
U.S.C.receive less compensation under a competitive agreement than
under a negotiated agreement.D.market and distribute an entire
issue of new securities within their own firm.E.pass the risk of
unsold shares back to the issuing firm via a firm commitment
agreement.
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Underwriters36.With firm commitment
underwriting, the issuing firm:A.is unsure of the total amount of
funds it will receive until after the offering is completed.B.is
unsure of the number of shares it will actually issue until after
the offering is completed.C.knows exactly how many shares will be
purchased by the general public during the offer period.D.retains
the financial risk associated with unsold shares.E.knows up-front
the amount of money it will receive from the stock offering.
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.4Topic: Firm commitment underwriting37.With Dutch
auction underwriting:A.each winning bidder pays the price he or she
bid.B.all successful bidders pay the same price.C.all bidders
receive at least a portion of the quantity for which they bid.D.the
selling firm receives the maximum possible price for each security
sold.E.the bidder for the largest quantity receives the first
allocation of securities.
Refer to section 15.4
AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning
Objective: 15-2Section: 15.4Topic: Dutch auction38.If an IPO is
underpriced then the:A.investors in the IPO are generally unhappy
with the underwriters.B.issue is less likely to sell out.C.stock
price will generally decline on the first day of trading.D.issuing
firm is guaranteed to be successful in the long term.E.issuing firm
receives less money than it probably should have.
Refer to section 15.5
AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning
Objective: 15-3Section: 15.5Topic: IPO underpricing39.Which of the
following have been offered as supporting arguments in favor of IPO
underpricing?I. Underpricing counteracts the "winner's curse".II.
Underpricing rewards institutional investors for sharing their
opinions of a stock's market value.III. Underpricing diminishes the
underwriting risk of a firm commitment underwriting.IV.
Underpricing reduces the probability that investors will sue the
underwriters.A.I and III onlyB.II and IV onlyC.I and II onlyD.I,
II, and III onlyE.I, II, III, and IV
Refer to section 15.5
AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning
Objective: 15-3Section: 15.5Topic: IPO underpricing40.Which one of
the following is a key goal of the aftermarket period?A.collection
of largest number of Dutch auction bids as possibleB.best
determination of a fair offer price for an upcoming IPOC.price
support for a new issue of securitiesD.establishment of a
broad-based underwriting syndicate for an upcoming IPOE.widest
distribution of red herrings as possible
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-3Section: 15.4Topic: Aftermarket period41.Which one of the
following statements is correct?A.The quiet period commences when a
registration statement is filed with the SEC and ends on the day
the IPO shares commence trading.B.Lockup agreements outline how
oversubscribed IPO shares will be allocated.C.Additional IPO shares
can be issued in accordance with the lockup agreement.D.Quiet
period restrictions only apply to the issuer of new securities.E.A
TV interview with a firm's CFO could cause a forced delay in the
firm's IPO.
Refer to section 15.4
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-3Section: 15.4Topic: IPO provisions42.An individual investor
with a small portfolio who wishes to purchase 100 shares of each
IPO is more likely to receive an allocation of shares when:A.an IPO
is substantially oversubscribed than when it is not.B.the
knowledgeable investors feel the issue is underpriced.C.an IPO is
severely underpriced.D.an IPO is undersubscribed.E.he or she has a
standing order with the underwriter to purchase shares in every IPO
handled by that underwriter.
Refer to section 15.5
AACSB: N/ABloom's: ComprehensionDifficulty: BasicLearning
Objective: 15-3Section: 15.5Topic: IPO allocations43.When a firm
announces an upcoming seasoned stock offering, the market price of
the firm's existing shares tends to:A.increase.B.decrease.C.remain
constant.D.respond but the direction of the response is not
predictable as shown by past studies.E.decrease momentarily and
then immediately increase substantially within an hour following
the announcement.
Refer to section 15.6
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.6Topic: Stock issue announcement44.The total direct
costs of underwriting an equity IPO:A.tends to increase on a
percentage basis as the proceeds of the IPO increase.B.is generally
between 7 and 8 percent, regardless of the issue size.C.can be as
high as 25 percent for small issues.D.excludes the gross
spread.E.excludes both the gross spread and the underpricing
cost.
Refer to section 15.7
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-3Section: 15.7Topic: Issue costs45.Which one of the following
statements is correct concerning the costs of issuing
securities?A.Domestic bonds are generally more expensive to issue
than equity IPOs.B.Abnormal returns are rarely associated with
seasoned issues.C.A seasoned offering is typically more expensive
on a percentage basis than an IPO.D.There tends to be substantial
economies of scale when issuing securities.E.The costs of issuing
convertible bonds tend to be less on a percentage basis than the
costs of issuing straight debt.
Refer to section 15.7
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-3Section: 15.7Topic: Issue costs46.Existing shareholders:A.may
or may not have a preemptive right to newly issued shares.B.must
purchase new shares whenever rights are issued.C.are prohibited
from selling their rights.D.are generally well advised to let the
rights they receive expire.E.can maintain their proportional
ownership positions without exercising their rights.
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Rights47.To purchase shares in a rights
offering, a shareholder generally just needs to:A.pay the
subscription amount in cash.B.submit the required form along with
the required number of rights.C.pay the difference between the
market price of the stock and the subscription price.D.submit the
required number of rights along with a payment for the underwriting
fee.E.submit the required number of rights along with the
subscription price.
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Rights48.The value of a right depends
upon:I. the number of rights required to purchase one new share.II.
the market price of the security.III. the subscription price.IV.
the price-earnings ratio of the stock.A.II and III onlyB.II and IV
onlyC.I and II onlyD.I, II, and III onlyE.I, II, III, and IV
Refer to section 15.8
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.8Topic: Rights49.Before a seasoned stock offering,
you owned 7,500 shares of a firm that had 500,000 shares
outstanding. After the seasoned offering, you still owned 7,500
shares but the number of shares outstanding rose to 625,000. Which
one of the following terms best describes this
situation?A.overallotmentB.percentage ownership dilutionC.Green
ShoeD.Red herringE.abnormal event
Refer to section 15.9
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.9Topic: Dilution50.Which one of the following
statements concerning dilution is correct?A.Dilution of percentage
ownership occurs whenever an investor participates in a rights
offer.B.Market value dilution increases as the net present value of
a project increases.C.Market value dilution occurs when the net
present value of a project is negative.D.Neither book value
dilution nor market value dilution has any direct bearing on
individual shareholders.E.Book value dilution is the cause of
market value dilution.
Refer to section 15.9
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-4Section: 15.9Topic: Dilution51.Which one of the following
statements is correct concerning the issuance of long-term debt?A.A
direct long-term loan has to be registered with the SEC.B.Direct
placement debt tends to have more restrictive covenants than
publicly issued debt.C.Distribution costs are lower for public debt
than for private debt.D.It is easier to renegotiate public debt
than private debt.E.Wealthy individuals tend to dominate the
private debt market.
Refer to section 15.10
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.10Topic: Long-term debt52.Shelf registration allows
a firm to register multiple issues at one time with the SEC and
then sell those registered shares anytime during the subsequent:A.3
months.B.6 months.C.180 days.D.2 years.E.5 years.
Refer to section 15.11
AACSB: N/ABloom's: KnowledgeDifficulty: BasicLearning Objective:
15-2Section: 15.11Topic: Shelf registration53.Aaron's Sailboats has
decided to take the company public by offering a total of 120,000
shares of common stock to the public. The firm has hired an
underwriter who arranges a full commitment underwriting and
suggests an initial selling price of $28 a share with an 8.5
percent spread. As it turns out, the underwriters only sell 97,400
shares. How much cash will Aaron's Sailboats receive from its first
public
offering?A.$2,727,200B.$2,495,388C.$3,074,400D.$3,360,000E.$3,645,600
Total cash received = 120,000 ( $28 (1 - 0.085) = $3,074,400
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.7Topic: Initial public offering54.Nelson
Paints recently went public by offering 65,000 shares of common
stock to the public. The underwriters provided their services in a
best efforts underwriting. The offering price was set at $16 a
share and the gross spread was $2. After completing their sales
efforts, the underwriters determined that they sold a total of
57,500 shares. How much cash did Nelson Paints receive from its
IPO?A.$805,000B.$910,000C.$920,000D.$1,035,000E.$1,040,000
Total cash received = 57,500 ( ($16 - $2) = $805,000
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.7Topic: Initial public offering55.Miller
Motors has decided to sell 1,600 shares of stock through a Dutch
auction. The bids received are as follows:
How much will Miller Motors receive in total from selling the
1,600 shares? Ignore all transaction and flotation
costs.A.$30,400B.$33,400C.$33,600D.$35,400E.$38,600
Total cash received = 1,600 ( $21 = $33,600
AACSB: AnalyticBloom's: AnalyticDifficulty: BasicLearning
Objective: 15-2Section: 15.4Topic: Dutch auction56.Bakers' Town
Bread is selling 1,200 shares of stock through a Dutch auction. The
bids received are as follows:
How much cash will Bakers' Town Bread receive from selling these
shares of stock? Ignore all transaction and flotation
costs.A.$10,800B.$12,000C.$13,400D.$14,400E.$16,800
Total cash received = 1,200 ( $10 = $12,000
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-2Section: 15.4Topic: Dutch auction57.Webster
Electrics is offering 1,500 shares of stock in a Dutch auction. The
bids include:
How much cash will Webster Electrics receive from selling these
shares? Ignore all transaction and flotation
costs.A.$28,500B.$30,000C.$31,500D.$33,000E.$34,500
Total cash received = 1,500 ( $21 = $31,500
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-2Section: 15.4Topic: Dutch auction58.You are a broker
and have been instructed to place an order for a client to purchase
500 shares of every IPO that comes to market. The next two IPOs are
each priced at $25 a share and will begin trading on the same day.
The client is allocated 500 shares of IPO A and 100 shares of IPO
B. At the end of the first day of trading, IPO A was selling for
$23.50 a share and IPO B was selling for $29 a share. What is the
client's total profit or loss on these two IPOs as of the end of
the first day of trading?A.-$425B.-$350C.$525D.$975E.$1,150
Total profit = [500 ( ($23.50 - $25)] + [100 ( ($29 - $25)] =
-$350
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.5Topic: IPO59.Richard has an outstanding
order with his stock broker to purchase 1,000 shares of every IPO.
The next three IPOs are each priced at $30 a share and will all
start trading on the same day. Richard is allocated 1,000 shares of
IPO A, 400 shares of IPO B, and 100 shares of IPO C. On the first
day of trading IPO A opened at $31.50 a share and ended the day at
$26 a share. IPO B opened at $31 a share and finished the day at
$32 a share. IPO C opened at $36.50 a share and ended the day at
$40.25 a share. What is Richard's total profit or loss on these
three IPOs as of the end of the first day of
trading?A.-$2,175B.-$1,850C.-$1,500D.$2,250E.$3,500
Total profit = [1,000 ( ($26 - $30)] + [400 ( ($32 - $30)] +
[100 ( ($40.25 - $30)] = -$2,175
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.5Topic: IPO60.Two IPOs will commence
trading next week. Scott places an order to buy 300 shares of IPO
A. Steve places an order to purchase 300 shares of IPO A and 300
shares of IPO B. Both IPOs are priced at $20 a share. Scott is
allocated 100 shares of IPO A. Steve is allocated 100 shares of IPO
A and 300 shares of IPO B. At the end of the first day of trading,
IPO A is selling for $22.70 a share and IPO B is selling for $18.60
a share. What is the difference in the total profits or losses that
Scott and Steve have as of the end of the first day of
trading?A.$120B.$240C.$360D.$420E.$580
Scott's profit = 100 ( ($22.70 - $20) = $270Steve's profit =
[100 ( ($22.70 - $20)] + [300 ( ($18.60 - $20)] = -$150Difference =
$270 - (-$150) = $420
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.5Topic: IPO61.Wear Ever is expanding and
needs $12.6 million to help fund this growth. The firm estimates it
can sell new shares of stock for $32.50 a share. It also estimates
it will cost an additional $340,000 for filing and legal fees
related to the stock issue. The underwriters have agreed to a 7.5
percent spread. How many shares of stock must Wear Ever sell if it
is going to have $12.6 million available for its expansion
needs?A.370,376 sharesB.419,127 sharesC.430,437 sharesD.454,209
sharesE.461,806 shares
Total value of issue = ($12,600,000 + $340,000)/(1 - 0.075) =
$13,989,189.19Number of shares needed = $13,989,189.19/$32.50 =
430,437 shares
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.7Topic: Issue costs62.Mountain Teas
wants to raise $11.6 million to open a new production center. The
company estimates the issue costs including the legal and
accounting fees will be $440,000. The underwriters have set the
stock price at $17.50 a share and the underwriting spread at 9
percent. How many shares of stock does Mountain Teas have to sell
to meet its cash need?A.728,414 sharesB.756,044 sharesC.769,315
sharesD.772,200 sharesE.781,909 shares
Total value of issue = ($11,600,000 + $440,000)/(1 - 0.09) =
$13,230,769Number of shares needed = $13,230,769/$17.50 = 756,044
shares
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.7Topic: Issue costs63.Outdoor Living
needs $7.5 million to finance modifications to its production
equipment because the design of its all-season tents has changed
dramatically. The underwriters estimate that the firm could sell
additional shares of stock at $14.50 a share with a 7.5 percent
underwriting spread. This would be a firm commitment underwriting.
The estimated issue costs are $121,000. How many shares of stock
will Outdoor Living need to sell to finance this project?A.568,201
sharesB.488,917 sharesC.452,311 sharesD.559,180 sharesE.562,400
shares
Total value of issue = ($7,500,000 + $121,000)/(1 - 0.075) =
$8,238,918.92Number of shares needed = $8,238,918.92/$14.50 =
568,201 shares
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.7Topic: Issue costs64.High Mountain
Mining wants to expand its current operations and requires $3.5
million in additional funding to do so. After discussing this with
key shareholders, the firm has decided to raise the necessary funds
through a rights offering at a subscription price of $18 a share.
The current market price of the firm's stock is $22 a share. How
many shares of stock will the firm need to sell through the rights
offering to fund the expansion plans?A.140,015 sharesB.159,091
sharesC.166,667 sharesD.194,444 sharesE.205,688 shares
$3.5m/$18 = 194,444 shares
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Rights offer65.Northwest Rail
wants to raise $14.2 million through a rights offering so it can
purchase additional rail cars and upgrade its maintenance
facilities. How many shares of stock will the firm need to sell
through this offering if the current market price is $34 a share
and the subscription price is $28 a share?A.417,647 sharesB.437,856
sharesC.458,065 sharesD.482,604 sharesE.507,143 shares
$14.2m/$28 = 507,143 shares
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Rights offer66.A.K. Stevenson
wants to raise $7.5 million through a rights offering. The
subscription price is set at $24. Currently, the company has 2.1
million shares outstanding with a current market price of $25 a
share. Each shareholder will receive one right for each share of
stock they currently own. How many rights will be needed to
purchase one new share of stock in this offering?A.6.40
rightsB.6.67 rightsC.6.72 rightsD.6.87 rightsE.7.00 rights
Number of rights issued = 1 ( 2.1m = 2.1m; Number of shares
needed = $7.5m/$24 = 312,500; Rights needed for each new share =
2.1m/312,500 = 6.72 rights
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Rights offer67.The Motor Plant
wants to raise $21.4 million through a rights offering so it can
modernize its facilities. The subscription price for the offering
is set at $12 a share. Currently, the company has 2.6 million
shares of stock outstanding at a market price of $12.50 a share.
Each shareholder will receive one right for each share of stock
they own. How many rights will a shareholder need to purchase one
new share of stock in this offering?A.1.46 rightsB.1.52
rightsC.1.55 rightsD.1.60 rightsE.1.67 rights
Number of rights issued = 1 ( 2.6m = 2.6m; Number of shares
needed = $21.4m/$12 = 1,783,333.33; Rights needed for each new
share = 2.6m/1,783,333.33 = 1.46 rights
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Rights offer68.Miller Fruit
wants to expand its citrus grove operations. The firm estimates
that it needs $8.6 million to buy land and establish its
operations. Currently, the firm has 540,000 shares of stock
outstanding at a market price per share of $34.80. If the firm
decides to raise the needed capital through a rights offering, one
right will be issued for each share of stock. The subscription
price will be set at $33 a share. How many rights will a
shareholder need to purchase one new share of stock in this
offering?A.2.07 rightsB.2.17 rightsC.2.22 rightsD.2.50 rightsE.2.67
rights
Number of rights issued = 1 ( 540,000 = 540,000; Number of
shares needed = $8.6m/$33 = 260,606.06; Rights needed for each new
share = 540,000/260,606.06 = 2.07 rights
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Rights offer69.Jefferson
Refining is issuing a rights offering wherein every shareholder
will receive one right for each share of stock they own. The new
shares in this offering are priced at $21 plus 3 rights. The
current market price of the stock is $23 a share. What is the value
of one right?A.$0.25B.$0.50C.$1.00D.$1.50E.$2.00
Value per share excluding right = [$21 + (3 ( $23)]/(1 + 3) =
$22.50Value of one right = $23 - $22.50 = $0.50
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Right value70.The stock of
Cleaner Home Products is currently selling for $26.40 a share. The
company has decided to raise funds through a rights offering
wherein every shareholder will receive one right for each share of
stock they own. The new shares being offered are priced at $25 plus
five rights. What is the value of one
right?A.$0.16B.$0.23C.$0.25D.$0.47E.$0.50
Cost per share = [$25 + (5 ( $26.40)]/(1 + 5) = $26.17Value of
right = $26.40 - $26.17 = $0.23
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.8Topic: Right value71.Barstow Industrial
Supply has decided to raise $27.52 million in additional funding
via a rights offering. The firm will issue one right for each share
of stock outstanding. The offering consists of a total of 860,000
new shares. The current market price of the stock is $35.
Currently, there are 5.16 million shares outstanding. What is the
value of one right?A.$0.37B.$0.43C.$0.48D.$0.52E.$0.60
Subscription price = $27.52m/860,000 shares = $32 a shareNumber
of shares issued = 1 ( 5.16m = 5.16mNumber of rights needed =
5.16m/860,000 = 6Cost per share = [$32 + (6 ( $35)]/(1 + 6) =
$34.57Value of a right = $35 - $34.57 = $0.43
AACSB: AnalyticBloom's: ApplicationDifficulty:
IntermediateLearning Objective: 15-4Section: 15.8Topic: Right
value72.You currently own 8 percent of the 3.5 million outstanding
shares of Webster Mills. The company has just announced a rights
offering with a subscription price of $28. One right will be issued
for each share of outstanding stock. This offering will provided $9
million of new financing for the firm, ignoring all issue costs.
Assume that all rights are exercised. What will be your new
ownership position if you opted to sell your rights rather than
exercise them personally?A.7.33 percentB.7.46 percentC.7.87
percentD.8.00 percentE.8.21 percent
Number of shares owned = 0.08 ( 3.5m = 280,000 sharesNumber of
shares offered = $9m/$28 = 321,428.57 sharesNew ownership position
= 280,000/(3.5m + 321,428.57) = 7.33 percent
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.9Topic: Dilution73.Jennifer owns 12,000
shares of Calico Clothing. Currently, there are 1.6 million shares
of stock outstanding. The company has just announced a rights
offering whereby 200,000 shares are being offered for sale at a
subscription price of $14 a share. The current stock price is $16 a
share. Assume that Jennifer sells her rights and that all rights
are exercised. What percentage of the firm will Jennifer own after
the rights offering?A.0.67 percentB.0.75 percentC.0.86
percentD.0.93 percentE.1.01 percent
New ownership percentage = 12,000/(1.6m + 0.2m) = 0.67
percent
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-4Section: 15.9Topic: Dilution74.Underwater
Experimental is considering a project which requires the purchase
of $498,000 of fixed assets. The net present value of the project
is $22,500. Equity shares will be issued as the sole means of
financing the project. What will the new book value per share be
after the project is implemented given the following current
information on the firm?
A.$13.25B.$13.70C.$14.23D.$14.94E.$15.60
Current market value per share = $936,000/60,000 = $15.60Number
of new shares needed = $498,000/$15.60 = 31,923.08 sharesNew book
value per share = ($720,000 + $498,000)/(60,000 + 31,923.08) =
$13.25
AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateLearning
Objective: 15-3Section: 15.9Topic: Book value75.Birds and More is
considering a project which requires the purchase of $164,000 of
fixed assets. The net present value of the project is $4,500.
Equity shares will be issued as the sole means of financing this
project. The price-earnings ratio of the project equals that of the
existing firm. What will the new market value per share be after
the project is implemented given the following current information
on the firm?
A.$20.68B.$20.72C.$20.80D.$20.95E.$21.10
Current market value per share = $457,600/22,000 = $20.80Number
of new shares needed = $164,000/$20.80 = 7,884.62 sharesNew market
value per share = ($457,600 + $164,000 + $4,500)/(22,000 +
7,884.62) = $20.95
AACSB: AnalyticBloom's: ApplicationDifficulty:
IntermediateLearning Objective: 15-3Section: 15.9Topic: Market
value76.Wagner Trucking is considering investing in a new project
that will cost $13 million and increase net income by 6.5 percent.
This project will be completely funded by issuing new equity
shares. Currently, the firm has 1.25 million shares of stock
outstanding with a market price of $42 per share. The current
earnings per share are $1.82. What will the earnings per share be
if the project is
implemented?A.$1.39B.$1.45C.$1.55D.$1.62E.$1.69
New earnings per share = ($1.82 ( 1.25m ( 1.065)/[1.25m +
($13m/$42)] = $1.55
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.9Topic: Earnings per share77.You own 15
percent or 13,500 shares of Printers, Etc. These shares have a
total market value of $426,600. By what percentage will the total
value of your investment in this firm change if the company sells
an additional 10,000 shares of stock at $30 a share and you do not
buy any?A.-1.37 percentB.-1.21 percentC.-0.51 percentD.1.03
percentE.1.29 percent
Current number of shares outstanding = 13,500/0.15 = 90,000Price
per share = $426,600/13,500 = $31.60New market value per share =
[(90,000 ( $31.60) + (10,000 ( $30)]/(90,000 + 10,000) =
$31.44Percent change = ($31.44 - $31.60)/$31.60 = -0.51 percent
AACSB: AnalyticBloom's: ApplicationDifficulty:
IntermediateLearning Objective: 15-3Section: 15.9Topic:
Dilution78.Kurt currently owns 3.4 percent of Northeastern
Transportation. The company has a total of 438,000 shares
outstanding with a current market price of $26.20 a share. At
present, the firm is offering an additional 25,000 shares at a
price of $25 a share. Kurt decides not to participate in this
offering. What will his ownership position be after the offering is
completed?A.3.06 percentB.3.22 percentC.3.27 percentD.3.40
percentE.3.51 percent
Number of shares owned = 0.034 ( 438,000 = 14,892New ownership
position = 14,892/(438,000 + 25,000) = 3.22 percent
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicLearning
Objective: 15-3Section: 15.9Topic: Dilution
Essay Questions
79.It can be argued that the decision to accept venture capital
is one of the most critical decisions an entrepreneur must make.
Explain why.
The potential rewards from venture capital can be substantial
but the costs to the entrepreneur are equally substantial. The
primary advantage of venture capital funding is the access to
capital when funds are unavailable from other sources. In addition,
a venture capitalist provides industry experience, expertise, and
valuable business contacts. However, nothing is free. In exchange
for this funding, entrepreneurs have to sacrifice a large
percentage of their ownership rights to the venture capitalist. If
venture capital is not accepted, the firm may fail for lacking of
funding. If venture capital is accepted, there's no guarantee of
success; only a guarantee that the entrepreneur will own less of
the firm.
AACSB: Reflective thinkingBloom's: AnalysisDifficulty:
BasicLearning Objective: 15-1Section: 15.1Topic: Venture
capital80.Explain both a rights offering and the basic
characteristics of a right.
A rights offering is an issue of common stock that is initially
offered for sale to a firm's current shareholders. Shareholders
generally receive one right for each share of stock owned. Each
right grants its holder the ability to purchase a stated amount of
new shares at a stated price during a stated period of time. If the
recipient of a right decides not to participate in the rights
offering, then he or she can sell that right to another investor
who does want to participate. Selling stock via a rights offering
is generally a cheaper method of issuing securities than a general
cash offer.
AACSB: Reflective thinkingBloom's: ComprehensionDifficulty:
BasicLearning Objective: 15-4Section: 15.8Topic: Rights
offer81.Explain why there is a tendency for IPOs to be
underpriced.
Several reasons have been given for underpricing an IPO. These
include:1. determining the correct offering price is extremely
difficult,2. underpricing helps ensure the success of the security
offering,3. underpricing is just an indirect cost of a securities
issue,4. underpricing rewards IPO investors for purchasing risky
securities,5. underpricing addresses the issue of the "winner's
curse", and6. underpricing rewards institutional investors for the
information they provide to underwriters regarding the potential
interest in and value of a security issue.
AACSB: Reflective thinkingBloom's: ComprehensionDifficulty:
BasicLearning Objective: 15-3Section: 15.5Topic: IPO
underpricing82.Firms encounter several costs when issuing new
securities. Identify and describe at least four of these costs.
Students should provide a partial discussion of the information
found at the beginning of SECTION 15.7 where 6 different types of
costs are identified and defined. These are:
AACSB: Reflective thinkingBloom's: KnowledgeDifficulty:
BasicLearning Objective: 15-3Section: 15.7Topic: Underwriting
costs83.Steve is the founder of Jefferson & Westover. Recently,
the firm decided to issue an IPO with Steve retaining 30 percent
ownership of the firm. The IPO agreement contained both a Green
Shoe provision and a 6-month lockup agreement. Steve's cost basis
per share is $15. The offering price for the IPO was $16. On the
first day of trading, the market price per share rose to $28.20 and
closed for the day at $25.60. Now, six months after the IPO
release, the stock is valued at $15.40 a share. Explain who
benefited the most during the lockup period, an outside investor or
Steve, and why.
As a company insider, the lockup agreement has prevented Steve
from selling any of his shares and benefiting from the substantial
price increase to $28.20 a share. Thus, Steve still owns all of his
shares and has a current profit of $0.40 a share. Meanwhile,
Outside Investor A could have purchased shares for $16 and sold
them at $28.20 each. Outside Investor B, could have bought the
shares at $28.20 and suffered a loss since the shares have declined
in value since that point. Thus, who is better off depends upon the
price at which the outside investor purchased shares.
AACSB: Reflective thinkingBloom's: AnalysisDifficulty:
IntermediateLearning Objective: 15-3Section: 15.4Topic: Lockup
agreement
Multiple Choice Questions
84.The Timken Company has announced a rights offer to raise $25
million for a new journal, the Journal of Financial Excess. This
journal will review potential articles after the author pays a
nonrefundable reviewing fee of $2,500 per page. The stock currently
sells for $48 per share, and there are 2.6 million shares
outstanding. The subscription price is set at $43 per share. What
is the ex-rights price per
share?A.$45.58B.$47.09C.$48.15D.$48.80E.$49.42
Number of new shares = $25m/$43 = 581,395.35Number of rights
needed to buy one share = 2.6m/581,395.35 = 4.472Ex-rights price
per share = [$43 + 4.472($48)]/[1 + 4.472] = $47.09
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicEOC #:
15-2Learning Objective: 15-4Section: 15.8Topic: Rights offer85.The
Warm Shoe Co. has concluded that additional equity financing will
be needed to expand operations and that the needed funds will be
best obtained through a rights offering. It has correctly
determined that as a result of the rights offering, the share price
will fall from $100 to $95 ($100 is the rights-on-price; $95 is the
ex-rights price, also known as the when-issued price). The company
is seeking $18 million in additional funds with a per-share
subscription price of $50. How many shares of stock are
outstanding, before the offering? (Assume that the increment to the
market value of the equity equals the gross proceeds of the
offering.)A.324,000B.360,000C.1,800,000D.3,240,000E.3,600,000
PEx = $95 = ($50 + $100N)/(N + 1); N = 9Number of new shares =
$18m/$50 = 360,000 sharesNumber of old shares = 9 ( 360,000 =
3,240,000 shares
AACSB: AnalyticBloom's: AnalysisDifficulty: BasicEOC #:
15-3Learning Objective: 15-4Section: 15.8Topic: Rights offer86.The
Woods Co. and the Mickelson Co. have both announced IPOs at $43 per
share. One of these is undervalued by $20, and the over is
overvalued by $14, but you have no way of knowing which is which.
You plan on buying 1,000 shares of each issue. If an issue is
underpriced, it will be rationed, and only half your order will be
filled. What is the amount of the difference between your expected
profit and the amount of profit you could earn if you could get
1,000 shares of Woods and 1,000 shares of
Mickelson?A.-$10,000B.-$6,000C.-$4,000D.$4,000E.$6,000
Expected profit = 500($20) + 1,000(-$14) = -$4,000Profit if
1,000 shares of each = 1,000($20) + 1,000(-$14) = $6,000Difference
= -$4,000 - $6,000 = -$10,000
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicEOC #:
15-4Learning Objective: 15-3Section: 15.5Topic: IPO
underpricing87.Flagler, Inc. needs to raise $30 million to finance
its expansion into new markets. The company will sell new shares of
equity via a general cash offering to raise the needed funds. The
offer price is $30 per share and the company's underwriters charge
a 10 percent spread. How many shares need to be sold?A.1,111,111
sharesB.1,250,000 sharesC.1,666,667 sharesD.2,500,000
sharesE.3,333,333 shares
Required sales proceeds: $30m = x (1 - 0.10); x =
$33,333,333Number of shares needed = $33,333,333/$30 =
1,111,111
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicEOC #:
15-5Learning Objective: 15-3Section: 15.7Topic: Flotation
costs88.The Educated Horses Corporation needs to raise $20 million
to finance its expansion into new markets. The company will sell
new shares of equity via a general cash offering to raise the
needed funds. Suppose the offer price is $40 per share and the
company's underwriters charge an 8 percent spread. The SEC filing
fee and associated administrative expenses of the offering are
$660,000. How many shares need to be
sold?A.448,907B.461,222C.511,111D.529,937E.561,413
Required sales proceeds: $20m + $0.66m = x (1 - 0.08); x =
$22,456,522Number of shares needed = $22,456,522/$40 = 561,413
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicEOC #:
15-6Learning Objective: 15-3Section: 15.7Topic: Flotation
costs89.The Huff Co. has just gone public. Under a firm commitment
agreement, Huff received $21.50 for each of the 6 million shares
sold. The initial offering price was $23.65 per share, and the
stock rose to $30.51 per share in the first few minutes of trading.
Huff paid $1,260,000 in direct legal and other costs, and $390,000
in indirect costs. The flotation costs were what percentage of the
funds raised?A.38.56 percentB.40.32 percentC.41.68 percentD.43.75
percentE.44.09 percent
Net amount raised = 6m ($21.50) - $1,260,000 - $390,000 =
$127,350,000Total direct costs = $1,260,000 + ($23.65 - $21.50)
(6m) = $14,160,000Total indirect costs = $390,000 = ($30.51 -
$23.65) (6m) = $41,550,000Total costs = $14,160,000 + $41,550,000 =
$55,710,000Flotation cost percentage = $55,710,000/$127,350,000 =
43.75 percent
AACSB: AnalyticBloom's: ApplicationDifficulty: BasicEOC #:
15-7Learning Objective: 15-3Section: 15.7Topic: Flotation
costs90.Mountain Homes wishes to expand its facilities. The company
currently has 7 million shares outstanding and no debt. The stock
sells for $55 per share, but the book value per share is $43. The
firm's net income is currently $9.1 million. The new facility will
cost $30 million, and it will increase net income by $309,000.
Assume the firm issues new equity to fund this expansion while
maintaining a constant price-earnings ratio. What will be the EPS
be after the new equity
issue?A.$1.25B.$1.30C.$1.35D.$1.40E.$1.45
Number of shares after the offering = 7m + ($30m/$55) =
7,545,454.545455New EPS = ($9.1m + $309,000)/7,545,454.545455 =
$1.25
AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #:
15-9Learning Objective: 15-3Section: 15.9Topic: Dilution91.The
Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify
its operations. Some recent financial information for the company
is shown here:
MHMM is considering an investment that has the same P/E ratio as
the firm. The cost of the investment is $798,270, and it will be
financed with a new equity issue. What would the ROE on the
investment have to be if we wanted the price after the offering to
be $110 per share? Assume the PE ratio remains constant.A.18.28
percentB.21.41 percentC.27.63 percentD.37.27 percentE.40.03
percent
Current ROE = $451,000/($4,631,000 - $2,315,500) = 0.19477435New
net income = 0.19477435 ($4,631,000 - $2,315,500 + $798,270) =
$606,483Number of new shares = $798,270/$110 = 7,257New EPS =
$606,483/(11,000 + 7,257) =$33.22Current P/E =
$110/($451,000/11,000) = 2.6829Necessary EPS = $110 =
2.6829(Necessary EPS); Necessary EPS = $41Necessary net income =
$41 (7,257) = $297,537New ROE = $297,537/$798,270 = 37.27
percent
AACSB: AnalyticBloom's: AnalysisDifficulty: IntermediateEOC #:
15-11Learning Objective: 15-3Section: 15.9Topic: Dilution92.Precise
Machining is considering a rights offer. The company has determined
that the ex-rights price would be $46. The current price is $53 per
share, and there are 7 million s