Intermediate Finance -- Chapter 15
Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. What is the cost of underpricing? A. $81 million B. $91 million C. $101 million D. $111 million
A. $81 million Cost of underpricing = ($70 - 43) × 3m = $81m
Which one of the following is not an advantage of shelf registration? A. The issuing firm can avoid competition from underwriters. B. Securities can be issued with short notice. C. Securities can be issued in small amounts without excessive costs. D. The firm can take advantage of market conditions.
A. The issuing firm can avoid competition from underwriters.
A firm's first offering of stock to the general public is known as: A. first-stage financing. B. an IPO. C. a general cash offer. D. a seasoned offering.
B. an IPO.
What is the primary reason for a reduction in share value after a successful rights issue? The new shares: A. have higher underwriting expenses. B. are offered at attractive prices. C. reduce the firm's return on equity. D. do not include voting rights.
B. are offered at attractive prices.
Which one of the following statements is generally true concerning the costs of issuing securities? A. Underpricing is rarely a significant cost. B. Legal and other administrative costs generally average less than $1 million. C. Debt is cheaper to issue than equity. D. There are no economies of scale in security issuance.
C. Debt is cheaper to issue than equity.
Prospective investors are advised of a stock's potential risks by the: A. underwriter. B. underpricing laws. C. prospectus. D. initial public offering.
C. prospectus.
Firms go public primarily to: A. raise additional capital. B. diversify public debt holders' risk. C. maintain ownership control. D. increase their financial leverage.
A. raise additional capital.
If an underwriter charges the public $40 per share for a new issue after having promised the issuer $38 per share, the spread per share is: A. $1. B. $2. C. $38. D. $40.
B. $2. Spread = $40 - 38 = $2
What was the market price of a share of stock before a rights issue, if one share of new stock could be purchased at $100 for every four shares that were previously owned? The stock price after the successful rights issue was $200. A. $220 B. $225 C. $240 D. $250
B. $225 $200 = [$100 + (4 × POld)]/(1 + 4); POld = $225
Some investors believe that the decision by management to issue equity as opposed to issuing debt is a signal that: A. the stock is currently undervalued. B. the stock is currently overvalued. C. the firm will avoid dilution of stock value. D. a shelf registration of securities will occur.
B. the stock is currently overvalued.
Those subject to the winner's curse are: A. underwriters. B. uninformed investors. C. firms issuing IPOs. D. venture capitalists.
B. uninformed investors.
A firm has just issued $250 million of equity which caused its stock price to drop by 3%. Calculate the loss in value of the firm's equity given that its market value of equity was $1 billion before the new issue. A. $7.5 million B. $30.0 million C. $33.3 million D. $37.5 million
B. $30.0 million Loss in value = 0.03 × $1 billion = $30 million
What is the market value placed on a firm in which an entrepreneur invests $1 million and a venture capitalist invests $3 million in first-stage financing for a 50% interest in the firm? A. $4 million B. $6 million C. $7 million D. $8 million
B. $6 million Firm value = $3m/0.5 = $6m
Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. What is the total cost of issuing the securities? A. $81 million B. $91 million C. $101 million D. $111 million
B. $91 million Total cost = [($70 - 40) × 3m] + $1m = $91m
An IPO was priced to sell at $23 a share and closed at $22 a share at the end of the first day of trading. The underwriting spread was 7% of the offer price and the legal, accounting and administrative costs were $1.6 million. What was the total percentage cost of the issue as a percentage of the market value at the end of the first day if 250,000 shares were offered? A. 38.87% B. 31.86% C. 42.08% D. 36.41%
B. 31.86% Total cost % = ({[$22 - $23 × (1 - 0.07)] × 250,000} + $1.6m)/($22 × 250,000) = 0.3186, or 31.86%
Which one of the following would not be included among the benefits of shelf registration? A. Reduction of lead time for security issuance B. No additional registration necessary for 5 years C. Issuer can take advantage of favorable conditions D. Issuer can search for best underwriting terms
B. No additional registration necessary for 5 years
Which one of the following methods may be particularly cost-effective to smaller issuers of securities? A. Seasoned offerings B. Private placement C. General cash offer D. Best efforts underwriting
B. Private placement
A major purpose of the prospectus is to: A. inform investors of the security's rate of return. B. advise investors of the security's potential risks. C. distribute stock warrants to prospective investors. D. list the security's dividend payment dates.
B. advise investors of the security's potential risks.
When underwriters offer a firm commitment on a stock issue, they: A. employ their best efforts in selling the stock. B. guarantee the net proceeds to the issuing firm. C. agree to purchase the venture capitalists' shares. D. assure purchasers that the stock will appreciate.
B. guarantee the net proceeds to the issuing firm.
One of the primary reasons for disbursing venture capital funds in installments is to: A. avoid tax liability. B. identify and cut losses early. C. increase the importance of the venture capitalist. D. take advantage of the time value of money.
B. identify and cut losses early.
Shelf registration allows firms to: A. purchase securities for up to 2 years without registration. B. incur only short time delays in selling securities. C. wait for 2 years before paying for securities. D. offer rights issues to the general public.
B. incur only short time delays in selling securities.
The Securities and Exchange Commission will not permit securities to be sold: A. if they have been overpriced. B. prior to approval of the registration statement. C. unless the issuer guarantees their value. D. until a shelf registration exists.
B. prior to approval of the registration statement.
Companies offering smaller security issues may prefer to issue them through a: A. private placement because lower rates of return can be offered. B. private placement because it is cheaper than a public issue. C. public issue because it is cheaper than a private placement. D. public issue because more exposure will be achieved.
B. private placement because it is cheaper than a public issue.
The primary reason for an underwriters' syndication is to: A. monitor the actions of the different underwriters. B. reduce the risk of selling a large issue. C. increase the size of the spread. D. avoid the scrutiny of the Securities and Exchange Commission.
B. reduce the risk of selling a large issue.
Which one of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution: A. acts as a signal to venture capitalists. B. repays debt held by the venture capitalist. C. retains a portion of the firm's equity. D. provides incentive to expend effort.
B. repays debt held by the venture capitalist.
One strategy that appears to be used by certain underwriters to reduce the risk of marketing a stock is to: A. offer a firm commitment on the issue. B. set the initial stock price below its true value. C. sell the securities in foreign countries. D. offer price rebates on the stock purchases.
B. set the initial stock price below its true value.
The direct expense of a stock issue includes the: A. cost of underpricing the stock. B. underwriting spread and other expenses. C. underwriting spread, other expenses, and cost of underpricing. D. underwriting spread.
B. underwriting spread and other expenses.
Money that is offered to finance a new business is known as: A. a general cash offer. B. venture capital. C. a private placement. D. a rights issue.
B. venture capital.
What would you expect to be the market price of stock after a sold-out rights issue, if each existing shareholder purchases one new share at $60 for each three that he or she currently holds, and the current share price is $100? A. $75 B. $80 C. $85 D. $90
D. $90 New price = [$60 + (3 × $100)]/(1 + 3) = $90
Plasti-tech Inc. has decided to go public and has sold 2 million of its shares to its underwriter for $20 per share. The underwriter then sold them to the public for $22 each. Plasti-tech also encountered $0.5 million in administrative fees. Soon after the issue, the stock price rose to $25. Find Plasti-tech Inc.'s total cost of this issue. A. $4.5 million B. $9.5 million C. $10.5 million D. $14.5 million
C. $10.5 million Total cost = [($25 - 20) × 2m] + $0.5m = $10.5m
An underwriter issues a firm commitment to sell 1 million shares at $20 each, including a $2 spread. How much does the issuing firm receive if only 500,000 shares are sold? A. $9 million B. $10 million C. $18 million D. $20 million
C. $18 million Proceeds to firm = ($20 - 2) × 1m = $18m
The consent of a corporation's stockholders must be received prior to any: A. issue of new securities. B. selection of an underwriter. C. increase in authorized capital. D. private placement of securities.
C. increase in authorized capital.
Stock that is sold through a rights issue: A. is offered for cash to the general investing public. B. will not affect the market price of the shares. C. is limited to sales to existing shareholders. D. must be sold on a firm commitment basis.
C. is limited to sales to existing shareholders.
When securities are issued under a rights issue: A. existing shareholders have the opportunity to expand their holdings. B. shares are offered to the public at a discount. C. the existing shares will increase in price. D. current shareholders have the right to resell their stock to the issuer.
A. existing shareholders have the opportunity to expand their holdings.
If a new stock offering were overpriced and could be sold, then the: A. existing shareholders would benefit. B. new investors would gain at the expense of the existing shareholders. C. firm could avoid the underwriting spread. D. firm could avoid the SEC filing.
A. existing shareholders would benefit.
If a corporation's management, with its superior knowledge of proposed investments, considers a security issue to be underpriced, it may react by: A. forgoing the security issuance and investment. B. lowering the price of the existing shares to equal the new shares. C. increasing the number of shares to be sold. D. adopting shelf registration, which automatically raises the issue price.
A. forgoing the security issuance and investment.
Second-stage financing occurs: A. prior to the initial public offering. B. when company founders sell a portion of their shares. C. after the best efforts of the underwriters. D. when the IPO does not raise sufficient cash.
A. prior to the initial public offering.
In regard to new issues of common stock, economists have found that the announcement of a new issue: A. results in a decline in the stock price. B. causes the stock price to rise. C. has no effect on the stock price. D. increases the market value of the stock but only temporarily.
A. results in a decline in the stock price.
When underwriters issue securities on a best efforts basis, they: A. sell as much of the stock as possible, but with no guarantee. B. submit a bid for purchase, which the issuer compares to other bids. C. buy the entire issue from the firm. D. guarantee that the issuer will be charged the minimum spread.
A. sell as much of the stock as possible, but with no guarantee.
Private placement of debt securities occurs more frequently in: A. smaller-sized firms. B. larger-sized firms. C. firms that are using venture capitalists. D. combination with convertible bonds.
A. smaller-sized firms.
The "winner's curse" is a reminder that: A. successful bidders may often overpay for an object. B. underwriters charge excessive fees. C. stocks are much riskier than bonds. D. underpricing an issue is a cost to existing owners.
A. successful bidders may often overpay for an object.
The most likely reason that underpricing of new issues occurs more frequently than overpricing is that: A. underwriters want to reduce the risk of a firm commitment. B. the demand for a new issue is typically too high. C. underwriters earn low rates of return. D. issuing firms demand that equity be underpriced.
A. underwriters want to reduce the risk of a firm commitment.
The enactment of shelf registration is likely to have increased: A. the cost of issuing new securities. B. the interests of venture capitalists. C. competition among underwriters. D. the underpricing of securities.
C. competition among underwriters.
An IPO was offered to the public at $18 a share with the issuing firm receiving $16.50 of that amount. The issuer incurred $750,000 in legal and administrative costs. At the end of the first trading day, the stock was priced at $22.40 a share. What was the total dollar cost, including both direct and indirect costs, of issuing the securities if 225,000 shares were offered? A. $1,687,500 B. $1,540,000 C. $2,077,500 D. $1,087,500
C. $2,077,500 Total cost = [($22.40 - 16.50) × 225,000] + $750,000 = $2,077,500
If an investor can earn 20% on underpriced IPOs, but will lose 10% on overpriced IPOs in which he was awarded $2,000 worth of shares, how much of the underpriced issue must he be awarded in order to gain $500 total? A. $1,500 B. $2,500 C. $3,500 D. $10,000
C. $3,500 $500 = (0.20 × value of shares) - (0.10 × $2,000); value of shares = $3,500
An investor exercises the right to buy one additional share at $20 for every five shares held. How much should each share be worth after the rights issue if they previously sold for $50 each? A. $35.00 B. $41.67 C. $45.00 D. $46.00
C. $45.00 New price = $20 + (5 × $50)/(1 + 5) = $45.00
A rights issue offers the firm's shareholders one new share of stock at $40 for every three shares of stock they currently own. What should be the stock price after the rights issue if the stock sells for $80 per share before the issue? A. $56.67 B. $60.00 C. $70.00 D. $71.33
C. $70.00 New price = [$40 + ($80 × 3)]/(1 + 3) = $70
How much will a firm receive in net funding from a firm commitment underwriting of 250,000 shares priced to the public at $40 if a 10% underwriting spread has been added to the price paid by the underwriter? Additionally, the firm pays $600,000 in legal fees. A. $8,400,000 B. $8,460,025 C. $8,490,909 D. $8,545,455
C. $8,490,909 Net proceeds = [($40/1.10) × 250,000] - $600,000 = $8,490,909
What percentage of direct expense is required to market stock if the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each? A. 6.98% B. 7.19% C. 7.75% D. 8.33%
C. 7.75% Direct expense % = {$1m + [($43 - 40) × 3m]}/($43 × 3m) = 0.0775, or 7.75%
A private placement avoids which one of the following costs? A. Depression in the stock price B. Administration costs C. Registration with the SEC D. Legal costs
C. Registration with the SEC
Which one of the following is correct if an underwriter is selling stock to the public at $40 per share, the underwriter receives a $3 per share spread, 2 million shares are sold, and the issuing firm receives $111 million from the underwriter? A. The underwriter's spread was greater than $3. B. The issue appreciated in price immediately. C. The issue included 3 million shares. D. The stock was issued on a best efforts basis.
C. The issue included 3 million shares. Proceeds to firm = $111m = ($40 - 3) × Number of shares; Number of shares = 3m
Currently, M & S Inc. has 2 million shares outstanding selling at $70 a share. A rights issue will be made that allows 1 share to be purchased for every 5 shares currently held by stockholders for $40 each. Which one of the following is true? A. The number of shares outstanding will fall to 1.6 million. B. The firm will raise $13.33 million. C. The stock price will fall to $65. D. The total value of the firm will equal $124 million.
C. The stock price will fall to $65. Number of shares issued: (2 million/5) = 400,000 Number of shares outstanding: 2 million + 0.4 million = 2.4 million Firm will raise: $40 × 400,000 = $16 million Total value of firm will increase from $140 million to $156 million Stock price will fall to: ($156 million/2.4 million) = $65
Underwriters are more likely to oversell new stock issues during: A. a bear market or market crash. B. a stable market period. C. a bull market or market boom. D. an extremely volatile market period.
C. a bull market or market boom.
In return for providing funds, venture capitalists generally require: A. collateral equal in value to the funds provided. B. first right to all of the firm's assets. C. an equity position in the firm. D. ownership of the entire firm.
C. an equity position in the firm.
Second stage financing: A. involves a substantial increase in leverage. B. immediately follows first-stage financing for every new business. C. may involve issuing additional shares of stock. D. occurs when the company is in danger of bankruptcy.
C. may involve issuing additional shares of stock.
A secondary offering IPO occurs when: A. new shares are sold to provide the company with additional funds. B. the second public issue of equity becomes available. C. the company's founders or venture capitalists market a portion of their shares. D. not all of the shares in a primary IPO were sold.
C. the company's founders or venture capitalists market a portion of their shares.
Studies have shown that, on average, new security issues are: A. subject to flotation costs of approximately 32%. B. overpriced by the amount of the spread. C. underpriced. D. overpriced to reward venture capitalists.
C. underpriced.
When underwriters are unsure of the demand for a new offering, they: A. reduce their spread. B. undertake the issue on a firm commitment basis. C. undertake the issue on a best efforts basis. D. provide shelf registration for the issue.
C. undertake the issue on a best efforts basis.
Assume an issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day's trading, the issuing company's stock price had risen to $70. In percentage terms, how much of the day's closing market value was absorbed by the total costs associated with the issue? A. 13.33% B. 23.33% C. 33.33% D. 43.33%
D. 43.33% Total cost % = {[($70 - 40) × 3m] + $1m}/($70 × 3m) = 0.4333, or 43.33%
Which one of these types of financing is most apt to provide investors with only sample products? A. Seasoned offering B. Rights offer C. IPO D. Crowdfunding
D. Crowdfunding
Which one of these terms applies to a public company offering new shares to the general public? A. Rights offer B. Initial public offering C. Venture capital offer D. General cash offer
D. General cash offer
Which one of the following statements is incorrect concerning private placements? A. Terms of the financing can be custom-tailored. B. The securities are not made available to the public. C. The securities are often less marketable. D. Only a small amount of corporate debt is financed in this manner.
D. Only a small amount of corporate debt is financed in this manner.
Who bears the bulk of the cost of underpricing an IPO? A. The underwriters B. The investors who purchase IPO shares C. All of the after-IPO shareholders D. The pre-IPO shareholders
D. The pre-IPO shareholders
Which one of the following is correct for stock issued under a firm commitment where the underwriter is to receive a spread of 8%? A. The underwriter's profits are guaranteed to be 8%. B. The underwriter must sell at least 92% of the shares. C. The underwriter receives 8% of all shares. D. The underwriter may suffer a loss on the issue.
D. The underwriter may suffer a loss on the issue.
Shelf registration was enacted to allow: A. the Department of Justice to prosecute those guilty of insider trading. B. the prospectus to be distributed after the sale of securities begins. C. underwriters to join together in syndication. D. a joint filing for multiple issues of a single security.
D. a joint filing for multiple issues of a single security.
A private placement of securities involves: A. selling only to the firm's current investors. B. nondisclosure of the issuing firm's name until after the sale. C. the exchange of convertible bonds for equity. D. a nonpublic sale of securities to a limited number of investors.
D. a nonpublic sale of securities to a limited number of investors.
The most important function of an underwriter is to: A. assess the firm's capital needs. B. approve the prospectus before distribution to the public. C. provide private placement of the firm's debt. D. buy the securities issue from the firm and resell the securities to the public.
D. buy the securities issue from the firm and resell the securities to the public.
Issue costs for equity are higher than those for debt for all of the following reasons except: A. equity issues have higher administrative costs. B. underwriting stock is riskier than underwriting bonds. C. equity issues involve significantly more time to sell. D. equity issues have no economies of scale.
D. equity issues have no economies of scale.
Stock underwriters are: A. investors seeking low prices. B. regulatory agencies that evaluate equity offerings. C. the firm's founders who guarantee a stock's performance. D. investment banking firms that coordinate equity offerings.
D. investment banking firms that coordinate equity offerings.
In a firm commitment, the underwriter: A. encounters virtually no risk because the spread is fixed. B. is allowed to sell the shares at any price they choose. C. is protected against being stuck with unsold shares. D. is allowed to sell the shares at a price slightly higher than the price it paid to the company.
D. is allowed to sell the shares at a price slightly higher than the price it paid to the company.
Blue-sky laws exist in order to: A. protect stock underwriters from fraudulent firms. B. restrict the amount of profit from IPOs. C. control the amount of stock owned by one investor. D. protect investors from deceptive firms.
D. protect investors from deceptive firms.
When a new issue goes wrong and the stock price immediately crashes once trading commences, the IPO investors are most apt to: A. only blame their bad luck. B. convert their shares into bonds. C. sue the company executives who are still shareholders. D. sue the underwriters for overhyping the issue.
D. sue the underwriters for overhyping the issue.