FIN303 chap 15

D Feedback: Stock price at end of first day = $61.00 First-day underpricing = ($61.00 - $50.00) = $11.00 per share. Total underpricing = ($11.00 per share x 500,000 shares of stock) = $5,500,000 Underwriter's gross spread ($50.00 x .12) =$6.00 per share. Underwriting cost = ($6.00 per share x 500,000 shares) = $3 million Total cost to the firm of selling the IPO = $3,000,000 + $600,000 + $5,500,000 = $9,100,000

77. A firm is making an initial public offering. The investment bankers agree to a firm underwriting commitment of 500,000 shares priced to the public at $50 a share. The underwriter's spread is 12%. In addition, the underwriter charges $600,000 in legal fees. On the first day of trading, the firm's stock closed at $61. What were the total costs of the issue? a. $3,000,000 b. $3,600,000 c. $8,500,000 d. $9,100,000

C

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 31. The initial seed money comes from A) public investors. B) investment banks. C) the entrepreneur or other founders. D) commercial banks.

A

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 32. Bootstrapping is the process by which A) many entrepreneurs raise "seed" money and obtain other resources necessary to start their businesses. B) the entrepreneur often fleshes out his or her ideas and makes them operational. C) most businesses are started by an entrepreneur. D) none of the above.

D

Format: Multiple Choice Learning Objective: LO 1 Level of Difficulty: Easy 33. Which one of the following statements is NOT true? A) The process by which many entrepreneurs raise "seed" money and obtain other resources necessary to start their businesses is often called bootstrapping. B) Most businesses are started by an entrepreneur who has a vision for a new business or product and a passionate belief in the concept's viability. C) The initial "seed" money usually comes from the entrepreneur or other founders. D) The seed money is spent on developing an initial public offering.

D

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 34. Which ONE of the following statements is true? A) The venture capital industry as we know it today emerged in the late 1960s with the formation of the first venture capital limited partnerships. B) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices. C) A significant number of venture capital firms focus on high-technology investments. D) All of the above are true statements.

B

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 35. Which one of the following statements is NOT true? A) Approximately $23 billion was invested in venture capital funds in 2010. B) The venture capital industry as we know it today emerged in the late 1990s. C) Modern venture capital firms tend to specialize in a specific line of business, such as hospitality, food manufacturing, or medical devices. D) A significant number of venture capital firms focus on high-technology investments.

C

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 36. Tactics that venture capitalists use to reduce the risk of their investment include A) funding the ventures in stages, requiring entrepreneurs to make no personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize. B) funding the ventures completely in the beginning, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize. C) funding the ventures in stages, requiring entrepreneurs to make personal investments, syndicating investments, and maintaining in-depth knowledge about the industry in which they specialize. D) None of the above.

B

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 37. Which one of the following statements is NOT true? A) Venture capitalists often require an entrepreneur to make a substantial personal investment in the business. B) Syndication occurs when the originating venture capitalist buys off other venture capitalists involved in the venture. C) Another factor that reduces risk is the venture capitalist's in-depth knowledge of the industry and technology. D) The key idea behind staged funding is that each funding stage gives the venture capitalist an opportunity to reassess the management team and the firm's financial performance.

B

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 38. Provisions that are part of venture capital agreements include A) timing of exit, number of board positions after exit, and what price is acceptable. B) timing of exit, the method of exit, and what price is acceptable. C) the method of exit, number of board positions after exit, and what price is acceptable. D) None of the above.

C

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 39. The three principal ways in which venture capital firms exit venture-backed companies are A) selling to a strategic buyer, buying out the founder, and offering stock to the public. B) selling to a strategic buyer, selling to a financial buyer, and buying out the founder. C) selling to a strategic buyer, selling to a financial buyer, and offering stock to the public. D) None of the above.

A

Format: Multiple Choice Learning Objective: LO 2 Level of Difficulty: Easy 40. Which ONE of the following statements is true? A) A typical venture capital fund may generate annual returns of 15 to 25 percent on the money that it invests, compared with an average annual return for the S&P 500 of almost 12 percent. B) A typical venture capital fund may generate annual returns of 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 20 percent. C) A typical venture capital fund may generate annual returns of 12 percent on the money that it invests, compared with an average annual return for the S&P 500 of about 25 percent. D) None of the above

B

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 41. Advantages of going public include all EXCEPT A) Larger amount of capital can be raised this way than the amount that can be raised through private sources. B) Publicly traded firms find it harder to attract top management talent. C) Going public can enable an entrepreneur to fund a growing business without giving up control. D) Additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost.

C

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Easy 42. Which ONE of the following statements is true? A) After the IPO, there is a less active secondary market for the firm's shares. B) Only smaller amounts of capital can be raised through an IPO than the amount that can be raised through private sources. C) Publicly traded firms find it easier to attract top management talent. D) Going public can enable an entrepreneur to fund a growing business but not without giving up control.

A

Format: Multiple Choice Learning Objective: LO 3 Level of Difficulty: Medium 43. Disadvantages of going public include all EXCEPT A) Managers' tendency to focus on long-term profits. B) The high cost of the IPO itself. C) The costs of complying with ongoing SEC disclosure requirements. D) The transparency that results from this compliance can be costly for some firms.

D

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 44. Basic services investment bankers provide when bringing securities to market include A) Origination B) Underwriting C) distribution. D) All of the above.

C

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 45. Which one of the following statements is NOT true? A) Investment bankers provide three basic services when bringing securities to market—origination, underwriting, and distribution. B) During the origination phase, the investment banker helps the firm determine whether it is ready for an IPO. C) Origination is the risk-bearing part of investment banking. D) Origination includes giving the firm financial advice and getting the issue ready to sell.

D

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 47. With a best-efforts underwriting A) the investment banking firm makes no guarantee to sell the securities at a particular price. B) the investment banker does not bear the price risk associated with underwriting the issue. C) compensation is based on the number of shares sold. D) All of the above.

B

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Easy 49. The three basic costs associated with issuing stock in an IPO are A) price premium, out-of-pocket expenses, and underpricing. B) underwriting spread, out-of-pocket expenses, and underpricing. C) underwriting spread, price premium, and underpricing. D) None of the above.

C

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 46. All of the following about a firm-commitment underwriting is true EXCEPT: A) The investment banker guarantees the issuer a fixed amount of money from the stock sale. B) The investment banker actually buys the stock from the firm. C) The issuer bears the risk that the resale price might be lower than the price the underwriter pays. D) The underwriter bears the risk that the resale price might be lower than the price the underwriter pays.

A

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 48. Which one of the following statements is NOT true? A) In a best-efforts offering, the underwriters will suffer a financial loss if the offer price is set too high. B) In a best-efforts agreement, the issuing firm will lose if the offer price is set too high. C) If the underpricing is significant, the investment banking firm will suffer a loss of reputation for failing to price the new issue correctly and raising less money for its client than it could have. D) Underpricing is defined as offering new securities for sale at a price below their true value.

C

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 50. Data from the marketplace show that the shares sold in an IPO are typically A) priced between 2 and 5 percent below the price at which they close at the end of first day of trading. B) priced between 10 and 15 percent above the price at which they close at the end of first day of trading. C) priced between 10 and 15 percent below the price at which they close at the end of first day of trading. D) priced between 2 and 5 percent above the price at which they close at the end of first day of trading.

C Feedback: Stock price at end of first day = $19.30 × (1.18) = $22.78 First-day underpricing = ($22.78 - $19.30) = $3.48 per share. Total underpricing = ($3.48 per share x 2,000,000 shares of stock) = $6,960,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 64. IPO pricing: Pau, Inc., issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the underpricing cost of issuing the securities to the firm? A) $13.6 million B) $20.6 million C) $6.96 million D) $7.57 million

A Feedback: Underwriter's gross spread ($19.30 - $12.50) =$6.80 per share. Number of shares outstanding = ($38.6 million/$19.30 per share) = 2 million. Underwriting cost = ($6.80 per share x 2.0 million shares) = $13.6 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 65. IPO pricing: Pau, Inc., issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the underwriting cost? A) $13.6 million B) $20.6 million C) $6.96 million D) None of the above.

B Feedback: Stock price at end of first day = $19.30(1.18) = $22.78 First-day underpricing = ($22.78 - $19.30) = $3.48 per share. Total underpricing = ($3.48 per share x 2,000,000 shares of stock) = $6,960,000 Underwriter's gross spread ($19.30 - $12.50) =$6.80 per share. Number of shares outstanding = ($38.6 million/$19.30 per share) = 2 million. Underwriting cost = ($6.80 per share x 2.0 million shares) = $13.6 million Total cost to the firm of selling the IPO = $13,960,000 + $270,000 + $6,960,000 = $20,830,000

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 66. IPO pricing: Pau, Inc., issues a $38.6 million IPO priced at $12.50 per share, and the offering price to the public is $19.30 per share. The firm's legal fees, SEC registration fees, and other administrative costs are $270,000. The firm's stock price increases 18 percent on the first day. What is the total cost of issuing the securities to the firm? A) $13.6 million B) $20.83 million C) $20.6 million D) None of the above

D Feedback: Change in price on first day = $24.70 - $19.00 = $5.70 Number of shares outstanding = 4.0 million Loss due to underpricing = $5.70 × 4,000,000 = $22.8 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 67. IPO underpricing: When Geo Corp. went public in September 2008, the offer price was $19.00 per share and the closing price at the end of the first day was $24.70. The firm issued 4 million shares. What was the loss to the company due to underpricing? A) $13.6 million B) $20.83 million C) $20.6 million D) $22.8 million

A Feedback: Gross proceeds from offer = $25.00 x 4,000,000 = $100,000,000 Underwriting spread = $100,000,000 x 0.18 = $18,000,000 Proceeds to issuer = ($23 x $4,000,000) - $18,000,000 = $74 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 68. IPO: Bethesda Biosys issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 18 percent of the offer price, which is set at $25 per share. Four million shares are issued. However, the bank was overly optimistic and eventually is able to sell the stock for only $23 per share. What are the proceeds for the issuer? A) $74 million B) $92 million C) $100 million D) None of the above

A Feedback: Number of shares issued = 5 million Net Proceeds to issuer = $110 million Underwriting spread = 20% Gross proceeds from offer = $110,000,000 / 0.80 = $137.5 million Selling price per share = $137.5 million / 5 million = $27.50

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 69. IPO: Fortune Hotels issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 20 percent. Five million shares are issued. However, the bank was overly optimistic and could not sell at the offer price of $31. If the net proceeds to the issuer were $110 million, what was the per share price at which the shares were sold? A) $27.50 B) $22 C) $31 D) None of the above

B Feedback: Number of shares issued = 5 million Net proceeds to issuer = $110 million Underwriting spread = 20% Gross proceeds from offer = $110,000,000 / 0.80 = $137.5 million Proceeds to underwriter = $137.5 million × 0.20 = $27.5 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 70. IPO: Fortune Hotels issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 20 percent. Five million shares are issued. However, the bank was overly optimistic and could not sell at the offer price of $31. If the net proceeds to the issuer is $110 million, how much did the investment bank receive? A) $22.0 million B) $27.5 million C) $31.0 million D) None of the above

C Feedback: Number of shares issued = 3 million Gross proceeds from issue = ($26.25 × 3,000,000) = $78,750,000 Underwriting spread = $78,750,000 x 0.16 = $12,600,000 Proceeds to issuer = $78,750,000 - $12,600,000 = $66.15 million

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 71. IPO: Dienz Pharma issues an IPO sold on a best-efforts basis. The company's investment bank demands a spread of 16 percent of the selling price. The offer price is set at $32 per share. Three million shares are issued. However, the bank was able to see the shares at $26.25 per share. What are the proceeds for the issuer? A) $96.00 million B) $78.75 million C) $66.15 million D) None of the above

Ans:A Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium

Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 76. The most likely reason that underpricing of new issues occurs more frequently than overpricing is the: A) Underwriters' desire to reduce the risk of a firm commitment. B) Demand for a new issue is typically too high. C) Underwriters earn low rates of return D) Issuing firms demand that equity be underpriced. E)

D

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Easy 51. Which one of the following statements is NOT true? A) In a competitive sale, the firm specifies the type and amount of securities it wants to sell. B) In a negotiated sale, the issuer selects the underwriter at the beginning of the origination process. C) In a general cash offer, management must decide whether to sell the securities on a competitive or a negotiated basis. D) For equity securities, competitive sales generally provide the lowest-cost method of sale.

A

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 52. Which one of the following statements is NOT true? A) Shelf registration gives firms less flexibility in bringing securities to market. B) During a two-year window, the firm can take the securities "off the shelf" and sell them as needed. C) Shelf registration allows firms to periodically sell small amounts of securities. D) A shelf registration statement can cover multiple securities, and there is no penalty if authorized securities are not issued.

C

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 53. Benefits from shelf registration include all EXCEPT: A) Greater flexibility in bringing securities to market. B) Shelf registration allows firms to periodically sell small amounts of securities and raise capital as needed. C) A shelf registration statement can cover multiple securities, but there is a penalty if authorized securities are not issued. D) Costs associated with selling the securities are reduced because only a single registration statement is required.

A Feedback: Underwriter's spread = 6 % Price per share the firm gets = 23.50*(1 - 0.06) = $22.09 Therefore, to raise $30 million, the company needs to issue: $30,000,000 / $22.09 = 1,358,081 new shares

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 72. General cash offering: Star Corporation, an auto fuel cell maker, is planning a new plant and needs to raise $30 million to finance it. The company plans to raise the money through a general cash offering priced at $23.50 a share. Star's underwriters charge a 6 percent spread. How many shares does the company have to sell to achieve its goal? A) 1,358,081 shares B) 1,276,596 shares C) 1,200,000 shares D) None of the above

D

Format: Multiple Choice Learning Objective: LO 5 Level of Difficulty: Medium 79. Why is the total cost of bringing a general cash offer to the market lower than issuing an IPO? a. They do not include a large underpricing b. Underwriting spreads are smaller c. There is less risk involved with a general cash offer than an IPO d. all of the above

D

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Easy 56. Advantages of private placements include: A) Cost of funds may be lower. B) Private lenders are more willing to negotiate changes to a bond contract. C) The speed of private placement deals and flexibility in issue size. D) All of the above.

B

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 54. Which one of the following statements is NOT true? A) For many smaller firms and firms of lower credit standing that have limited access, or no access, to the public markets, the cheapest source of external funding is often the private markets. B) Bootstrapping and venture capital financing are not part of the private market. C) Bootstrapping and venture capital financing are part of the private market. D) Many private companies that are owned by entrepreneurs, families, or family foundations and are sizable companies of high credit quality prefer to sell their securities in the private markets.

B

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 55. Which one of the following statements is NOT true? A) Private placement occurs when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals. B) All corporate debt is sold through the private placement market. C) About half of all corporate debt is sold through the private placement market. D) Investment banks and money center banks often assist firms with private placements.

C

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 57. Which one of the following statements is NOT true? A) Private equity firms pool money from wealthy investors, pension funds, insurance companies, and other sources to make investments. B) Private equity firms invest in more mature companies. C) Private equity firms invest in new companies. D) Private equity investors focus on firms that have stable cash flows because they use a lot of debt to finance their acquisitions.

A

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 59. Which one of the following statements is NOT true? A) PIPE transactions are registered with the SEC. B) PIPE transactions are not registered with the SEC. C) In a PIPE transaction, investors purchase securities (equity or debt) directly from a publicly traded company in a private placement. D) The securities are virtually always sold to the investors at a discount to the price at which they would sell in the public markets.

B

Format: Multiple Choice Learning Objective: LO 6 Level of Difficulty: Medium 60. Which ONE of the following statements is true? A) Under federal securities law, they can be resold to investors in the public markets immediately even if they are not registered. B) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC, usually within 90 days of the PIPE closing. C) As part of the PIPE contract, the company often agrees to register the restricted securities with the SEC after 90 days of the PIPE closing. D) PIPE transactions involving a healthy firm can also be executed without the use of an investment bank but result in a cost increase of 7 to 8 percent of the proceeds.

D

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 58. Private equity firms improve the performance of firms in which they invest by: A) making sure that the firms have the best possible management teams. B) closely monitoring each firm's performance and providing advice and counsel to the firm's management team. C) facilitating mergers and acquisitions that help improve the competitive positions of the companies in which they invest. D) All of the above.

C Feedback: Prime rate = PR = 7.5% Maturity risk premium = MAT = 0.75% Default risk premium = DRP = 1.5% Cost of loan = k = PR + DRP + MAT = 7.5% + 1.5% = 0.75% = 9.75%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 73. Bank lending: Jasper, Inc., is looking for a five-year term loan of $3 million. Its bank is willing to make the loan. The firm will have to pay a premium of 1.5 percent for default risk and another 0.75 percent for maturity risk. The current prime rate is 7.5 percent. What is the loan rate on this bank loan? A) 9% B) 8.25% C) 9.75% D) None of the above

B Feedback: Prime rate =PR = 5.75%; Maturity risk premium = MAT = k10-year - kT-bill = 4.24% - 3.54% = 0.70% Borrowing rate for firm A = k = Prime rate + MAT = 5.75% + 0.70% = 6.45% Borrowing rate for firm B = k = Prime rate + 2% + MAT = 5.75% + 2% + 0.70% = 8.45%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 74. Bank lending: Suppose two firms want to borrow money from a bank for a period of 10 years. Firm A has excellent credit and can borrow at the prime rate, whereas Firm B's credit standing is prime + 2. The current prime rate is 5.75 percent, the 30-year Treasury bond yield is 4.35 percent, the three-month Treasury bill yield is 3.54 percent, and the 10-year Treasury note yield is 4.24 percent. What are the appropriate loan rates for each customer? A) 6.45%, 7.75% B) 6.45%, 8.45% C) 5.75%, 8.45% D) None of the above

A Feedback: Prime rate =PR = 6.5%; Default risk premium = DRP = 1.5% Maturity risk premium = MAT = k5-year - kT-bill = 4.25% - 3.25% = 0.725% Borrowing rate for firm A = k = PR +DRP+ MAT = 6.5% + + 1.5% + 0.725% = 8.725%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 75. Bank lending: Marigold Corp. wants to borrow money from Howard Bank for a period of five years. The firm's credit standing calls for a premium of 1.5 percent over the prime rate. The current prime rate is 6.5 percent, the 30-year Treasury bond yield is 5.375 percent, the three-month Treasury bill yield is 3.525 percent, and the 5-year Treasury note yield is 4.25 percent. What is the appropriate loan rate for this customer? A) 8.725% B) 7.225% C) 6.500% D) None of the above

B Feedback: kl = 2.75 + 1.80 + 0.50 = 5.05%

Format: Multiple Choice Learning Objective: LO 7 Level of Difficulty: Medium 78. Castle Co. needs to borrow $10 million for process improvement upgrades. Management decides to sell 20-year bonds. They determine that the 3-month Treasury bill rate is 2.75 percent, the firm's credit rating is A, and the yield on 20-year Treasury bonds is 1.80 percent higher than that for 3-month Treasury bills. Bonds with an A rating are selling for 50 basis points above the 20-year Treasury bond rate. What is the borrowing cost to do this transaction? a. 4.55% b. 5.05% c. 7.75% d. 9.55%

B Feedback: Underwriter's gross spread ($22 - $17) =$5 per share. Number of shares outstanding = ($66 million/$22 per share) = 3 million. Underwriting cost = ($5 per share x 3.0 million shares) = $15.0 million

Reference: Ref 15-1 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 61. What is the underpricing spread? A) $51 million B) $15 million C) $66 million D) None of the above.

A Feedback: Stock price at end of first day = $22(1.15) = $25.30 First-day underpricing = ($25.30 - $22) = $3.30 per share. Total underpricing = ($3.30 per share x 3,000,000 shares of stock) = $9,900,000

Reference: Ref 15-1 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 62. What is the underpricing on this issue? A) $9,900,000 B) $24,900,000 C) $15,000,000 D) None of the above.

C Feedback: Total cost to the firm of selling the IPO = $15,000,000 + $350,000 + $9,900,000 = $25,250,000

Reference: Ref 15-1 Format: Multiple Choice Learning Objective: LO 4 Level of Difficulty: Medium 63. What is the firm's total cost of issuing the securities? A) $24.9 million B) $15.35 million C) $25.25 million D) None of the above