Question

(Instructor Problem: Estimating Cost of Issuance – no solutions will be provided) Your firm has 10 million shares outstanding, and you are about to issue 5 million new shares in an IPO. The IPO price has been set at $20 per share, and the underwriting spread is 7%. The IPO is a big success with investors, and the share price rises to $50 on the first day of trading.

a. How much did your firm raise from the IPO?

b. What is the market value of the firm after the IPO?

c. Assume that the post-IPO value of your firm is its fair market value. Suppose your firm could have issued shares directly to investors at their fair market value, i.e., with no underwriting spread and no underpricing. What would the IPO share price have been in this case, if the firm raises the same amount as in part (a)?

d. Based on the analysis in previous parts, what is the total IPO cost to the firm’s original investors? e. Who lost from underpricing? Who benefited? Explain.

Answer 1

a) IPO Proceeds = 5,000,000 * 20 = 100 million

Less : underwriting spread @ 7% = 7 million

Net amount raised = 93 million

b) Total no of shares after IPO = 10 + 5 = 15 million

Share price after listing = 50

Market Value = 50 * 15 million = 750 million

c) IPO share price in this case would be 50 per share

d) by issuing 5 million shares at 50 firm could have raised (5 *50 ) = 250 million instead of just 93 millions calculated in part a

IPO cost to orignal investors = 250 - 93 = 157 million

e)

Origbal Investor	157	loss
underwritor	7	profit
New shareholders (50-20)*5 million	150	profit