Common Products has just made its first issue of stock. It raised $1.2 million by selling 150,000

Common Products has just made its first issue of stock. It raised $1.2 million by selling 150,000 shares of stock to the public. These are the only shares outstanding. The par value of each share was $3. Complete the following table:

Common shares (par value)	$
Additional paid-in capital	$
Retained earnings	$
Net common equity	$ 1,600,000

Explanation:

Common shares (par value) = 150,000 × $3 = $450,000

Additional paid in capital = funds raised − par value = $1,200,000 − $450,000 = $750,000

Because net common equity of the firm is $1,600,000 and the book value of outstanding stock is $1,200,000, then retained earnings equals $400,000.

Having heard about IPO underpricing, I put in an order to my broker for 1,700 shares of every IPO he can get for me. After 3 months, my investment record is as follows:

IPO	Shares Allocated  to Me	Price per  Share	Initial Return
A	900	$25	6%
B	600	35	13
C	1,700	5	−6
D	0	9	15

a.	What is the average underpricing of this sample of IPOs?

Average underpricing

%

b.	Calculate the average initial return, weighting by the amount of money invested in each issue. (Round your answer to 2 decimal places.)

Average initial return

%

Explanation:

a.

Average underpricing can be estimated as the average initial return on the sample of IPOs:

(6% + 13% − 6% + 15%)/4 = 7%

b.

The average initial return, weighted by the amount invested in each issue, is calculated as follows:

	Investment (shares × price)	Initial Return	Profit (% return × investment)
A	$  22,500	6%	$1,350
B	21,000	13%	2,730
C	8,500	−6%	−510
D	0	15%	0
Total	$52,000		$3,570

Average return = $3,570/$52,000 = 0.0687 = 6.87%

Moonscape has just completed an initial public offering. The firm sold 5 million shares at an offer price of $10 per share. The underwriting spread was $.4 a share. The price of the stock closed at $15 per share at the end of the first day of trading. The firm incurred $500,000 in legal, administrative, and other costs. What were flotation costs as a fraction of funds raised? (Do not round intermediate calculations. Round your answer to 1 decimal place.)

Fraction of funds raised

%

Explanation:

Underwriting costs for Moonscape:

Underwriting spread: $0.40 × 5 million	$	2.0 million
Underpricing: $5.00 × 5 million		25.0 million
Other direct costs		0.5 million
Total	$	27.5 million

Funds raised = $10 × 5 million = $50 million

Flotation costs	=	27.5	= 0.550 = 55.0%
Funds raised		50

When Microsoft went public, the company sold 2 million new shares (the primary issue). In addition, existing shareholders sold .9 million shares (the secondary issue) and kept 22.8 million shares. The new shares were offered to the public at $24, and the underwriters received a spread of $1.51 a share. At the end of the first day’s trading the market price was $38 a share.

a.	How much money did the company receive before paying its portion of the direct costs? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Amount received

$ million

b.	How much did the existing shareholders receive from the sale before paying their portion of the direct costs? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Amount received

$ million

c.	If the issue had been sold to the underwriters for $33 a share, how many shares would the company have needed to sell to raise the same amount of cash? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Number of shares

million

d.	How much better off would the existing shareholders have been? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.)

Gain to shareholders

$ million

Explanation:

a.

The price of each share, net of the underwriting spread, was $24 − $1.51 = $22.49.

Therefore, by selling new stock in the primary issue, the company received:

2 million × $22.49 = $44.98 million

b.

The existing shareholders sold their 900,000 shares to the underwriters for total proceeds of 900,000 × $22.49 = $20.24 million.

c.

If the underwriters had paid $33 per share, the number of new shares the company would have needed to sell is $44.98 million/$33 = 1.36 million.

d.

If the existing shareholders had sold their 900,000 shares to the underwriters for $33 per share, rather than $22.49, the increase in their proceeds would have been:

900,000 × ($33.00 − $22.49) = $9.46 million