Question

Astro Investment Bank offers Lunar Vacations the following options on its initial public sale of​ equity:​(a​) a best efforts arrangement whereby Astro will keep %2.3% of the retail sales or ​(b​) a firm commitment arrangement of ​$10,200,000. Lunar plans on offering 1,000,000 shares at ​$11.87 per share to the public. If it sells 100% of the​ shares, which is the better choice for Lunar​ Vacations? Which is the better choice for Astro Investment​ Bank?

a) Under the best efforts​ arrangement, what are the proceeds for Lunar​ Vacations?

b) Under the firm commitment arrangement, what are the proceeds for Lunar​ Vacations?

c) Under the best efforts​ arrangement, what are the proceeds for Astro Investment Bank?

d) Under the firm commitment​ arrangement, what are the proceeds for Astro Investment Bank?

Answer 1

As 100% of the shares are sold total value of IPO = 1,000,000 shares * $11.87 per share

= $11,870,000

(a): Proceeds for Lunar Vacations under the best efforts arrangement = 11,870,000*(1-2.3%) = $11,596,990

(b); Proceeds for Lunar Vacations under the firm commitment arrangement = $10,200,000

(c): Proceeds for Astro Investment Bank under the best efforts arrangement = 11,870,000*2.3% = $273,010

(d): Proceeds for Astro Investment Bank under the firm commitment arrangement = 11,870,000 - 10,200,000 = $1,670,000

Thus the better choice for Lunar​ Vacations is best efforts arrangement (as the net proceeds are higher in this case).

Better choice for Astro Investment​ Bank is firm commitment arrangement (as their earnings is higher in this case).