Chap 015

Chapter 15 - Raising Capital

Chapter 15 Raising Capital Multiple Choice Questions

1. Jones & Co. is funded by a group of individual investors for the sole purpose of providing funding for individuals who are trying to convert their new ideas into viable products. What is this type of funding called? A. green shoe funding B. tombstone underwriting C. venture capital D. red herring funding E. life cycle capital

2. What is the form called that is filed with the SEC and discloses the material information on a securities issuer when that issuer offers new securities to the general public? A. prospectus B. red herring C. indenture D. public disclosure statement E. registration statement

3. Miller & Chase is offering $4 million of new securities to the general public. Which SEC regulation governs this offering? A. Regulation A B. Regulation C C. Regulation G D. Regulation Q E. Regulation R

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4. What is a prospectus? A. a letter issued by the SEC authorizing a new issue of securities B. a report stating that the SEC recommends a new security to investors C. a letter issued by the SEC that outlines the changes required for a registration statement to be approved D. a document that describes the details of a proposed security offering along with relevant information about the issuer E. an advertisement in a financial newspaper that describes a security offering

5. Which one of the following is a preliminary prospectus? A. tombstone B. green shoe C. registration statement D. rights offer E. red herring

6. Advertisements in a financial newspaper announcing a public offering of securities, along with a list of the investment banks handling the offering, are called: A. red herrings. B. tombstones. C. Green Shoes. D. registration statements. E. cash offers.

7. What is an issue of securities that is offered for sale to the general public on a direct cash basis called? A. best efforts underwriting B. firm commitment underwriting C. general cash offer D. rights offer E. herring offer

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8. Tony currently owns 12,000 shares of GL Tools. He has just been notified that the firm is issuing additional shares of stock and that he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called? A. best efforts offer B. firm commitment offer C. general cash offer D. rights offer E. priority offer

9. Soup Galore is a partnership that was formed three years ago for the purpose of creating, producing, and distributing healthy soups in a dried form. The firm has been extremely successful thus far and has decided to incorporate and offer shares of stock to the general public. What is this type of an equity offering called? A. venture capital offering B. shelf offering C. private placement D. seasoned equity offering E. initial public offering

10. What is a seasoned equity offering? A. an offering of shares by shareholders for repurchase by the issuer B. shares of stock that have been recommended for purchase by the SEC C. equity securities held by a firm's founder that are being offered for sale to the general public D. sale of newly issued equity shares by a firm that is currently publicly owned E. a set number of equity shares that are issued and offered to the public annually

11. Executive Tours has decided to take its firm public and has hired an investment firm to handle this offering. The investment firm is serving as a(n): A. aftermarket specialist. B. venture capitalist. C. underwriter. D. seasoned writer. E. primary investor.

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12. What is the definition of a syndicate? A. a venture capitalist B. a group of attorneys providing services for an IPO C. block of investors who control a firm D. a bank that loans funds to finance the start-up of a new firm E. a group of underwriters sharing the risk of selling a new issue of securities

13. The difference between the underwriters' cost of buying shares in a firm commitment and the offering price of those securities to the public is called the: A. gross spread. B. under price amount C. filing fee. D. new issue premium. E. offer price.

14. D.L. Jones & Co. recently went public. The firm received $20.80 a share on the entire offer of 25,000 shares. Keeser & Co. served as the underwriter and sold 23,700 shares to the public at an offer price of $22 a share. What type of underwriting was this? A. best efforts B. shelf C. over subscribed D. private placement E. firm commitment

15. Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public. The underwriters charged a fee of 8 percent and paid Blue Stone Builders $16.40 a share on 40,000 shares. Which one of the following terms best describes this underwriting? A. best efforts B. shelf C. direct rights D. private placement E. firm commitment

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16. The 40-day period following an IPO during which the SEC places restrictions on the public communications of the issuer is known as the _____ period. A. silent B. quiet C. lockup D. green E. red

17. Denver Liquid Wholesalers recently offered 50,000 new shares of stock for sale. The underwriters sold a total of 53,000 shares to the public. The additional 3,000 shares were purchased in accordance with which one of the following? A. Green shoe provision B. Red herring provision C. quiet provision D. lockup agreement E. post-issue agreement

18. Shares of PLS United have been selling with rights attached. Tomorrow, the stock will sell independent of these rights. Which one of the following terms applies to tomorrow in relation to this stock? A. pre-issue date B. aftermarket date C. declaration date D. holder-of-record date E. ex-rights date

19. The date on which a shareholder is officially listed as the recipient of stock rights is called the: A. issue date. B. offer date C. declaration date D. holder-of-record date. E. ex-rights date.

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20. A rights offering in which an underwriting syndicate agrees to purchase the unsubscribed portion of an issue is called a _____ underwriting. A. standby B. best efforts C. firm commitment D. direct fee E. tombstone

21. The amount paid to an underwriter who participates in a standby underwriting agreement is called a(n): A. gross spread. B. optional spread. C. standby fee. D. additional fee. E. oversubscription fee.

22. Franklin Minerals recently had a rights offering of 1,000 shares at an offer price of $10 a share. Isabelle is a shareholder who exercised her rights option by buying all of the rights to which she was entitled based on the number of shares she owns. Currently, there are six shareholders who have opted not to participate in the rights offering. Isabelle would like to purchase the unsubscribed shares. Which one of the following will allow her to do so? A. standby provision B. oversubscription privilege C. open offer privilege D. new issues provision E. overallotment provision

23. Roy owns 200 shares of R.T.F., Inc. He has opted not to participate in the current rights offering by this firm. As a result, Roy will most likely be subject to: A. an oversubscription cost. B. underpricing. C. dilution. D. the Green Shoe provision. E. a locked in period.

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24. Direct business loans typically ranging from one to five years are called: A. private placements. B. debt SEOs. C. notes payable. D. debt IPOs. E. term loans.

25. A group of five private investors recently loaned $6 million to Henderson Hardware for ten years at 9 percent interest. This loan is best described as a: A. private placement. B. debt SEO. C. notes payable. D. debt IPO. E. term loan.

26. Pearson Electric recently registered 250,000 shares of stock under SEC Rule 415. The firm plans to sell 150,000 shares this year and the remaining 100,000 shares next year. What type of registration was this? A. standby registration B. shelf registration C. Regulation A registration D. Regulation Q registration E. private placement registration

27. Suzie is a chemist who has been experimenting with fragrances in her home laboratory and feels that she now has three viable perfumes that could be successfully marketed. She knows a venture capitalist who has offered to finance her business to the point where she would be ready to begin the manufacturing and marketing stage. Which type of financing is Suzie being offered? A. syndicate B. introduction C. second-stage D. mezzanine-level E. seed money

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28. Which one of the following is probably the most successful means of finding venture capital? A. internet searches B. Dutch auctions C. newspaper advertisements D. personal contacts E. personal letters to venture capital firms

29. Which one of the following statements concerning venture capital financing is correct? A. Venture capitalists desire shares of common stock but avoid preferred stock. B. Venture capital is relatively easy to obtain. C. Venture capitalists rarely assume active roles in the management of the financed firm. D. Venture capitalists often require at least a forty percent equity position as a condition of financing. E. Venture capital is relatively inexpensive in today's competitive markets.

30. Which one of the following statements concerning venture capitalists is correct? A. Venture capitalists assume management responsibility for the firms they finance. B. Exit strategy is a key consideration when selecting a venture capitalist. C. Venture capitalists limit their services to providing money to start-up firms. D. Most venture capitalists are long-term investors in a firm. E. A venture capitalist normally invests in a new idea and finances that idea until the newlyformed firm can issue an IPO.

31. Which of the following should be considered when selecting a venture capitalist? I. level of involvement II. past experiences III. termination of funding IV. financial strength A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and IV only E. I, II, III, and IV

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32. Trevor is the CEO of Harvest Foods, which is a privately-held corporation. What is the first step he must take if he wishes to take Harvest Foods public? A. select an underwriter B. obtain SEC approval C. gain board approval D. prepare a registration statement E. distribute a prospectus

33. All new interstate security issues are regulated by the: A. registration statement. B. Green Shoe provision. C. Securities Exchange Act of 1934. D. Securities Act of 1933. E. Federal Reserve Act of 1931.

34. The Securities and Exchange Commission: A. verifies the accuracy of the information contained in the prospectus. B. verifies the accuracy of the information contained in the red herring. C. examines the registration statement during the Green Shoe period. D. is concerned only that an issue complies with all rules and regulations. E. determines the final offer price once they have approved the registration statement.

35. Underwriters generally: A. pay a spread to the issuing firm. B. provide only best efforts underwriting in the U.S. C. receive less compensation under a competitive agreement than under a negotiated agreement. D. market and distribute an entire issue of new securities within their own firm. E. pass the risk of unsold shares back to the issuing firm via a firm commitment agreement.

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36. With firm commitment underwriting, the issuing firm: A. is unsure of the total amount of funds it will receive until after the offering is completed. B. is unsure of the number of shares it will actually issue until after the offering is completed. C. knows exactly how many shares will be purchased by the general public during the offer period. D. retains the financial risk associated with unsold shares. E. knows up-front the amount of money it will receive from the stock offering.

37. With Dutch auction underwriting: A. each winning bidder pays the price he or she bid. B. all successful bidders pay the same price. C. all bidders receive at least a portion of the quantity for which they bid. D. the selling firm receives the maximum possible price for each security sold. E. the bidder for the largest quantity receives the first allocation of securities.

38. If an IPO is underpriced then the: A. investors in the IPO are generally unhappy with the underwriters. B. issue is less likely to sell out. C. stock price will generally decline on the first day of trading. D. issuing firm is guaranteed to be successful in the long term. E. issuing firm receives less money than it probably should have.

39. Which of the following have been offered as supporting arguments in favor of IPO underpricing? I. Underpricing counteracts the "winner's curse". II. Underpricing rewards institutional investors for sharing their opinions of a stock's market value. III. Underpricing diminishes the underwriting risk of a firm commitment underwriting. IV. Underpricing reduces the probability that investors will sue the underwriters. A. I and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV

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40. Which one of the following is a key goal of the aftermarket period? A. collection of largest number of Dutch auction bids as possible B. best determination of a fair offer price for an upcoming IPO C. price support for a new issue of securities D. establishment of a broad-based underwriting syndicate for an upcoming IPO E. widest distribution of red herrings as possible

41. Which one of the following statements is correct? A. The quiet period commences when a registration statement is filed with the SEC and ends on the day the IPO shares commence trading. B. Lockup agreements outline how oversubscribed IPO shares will be allocated. C. Additional IPO shares can be issued in accordance with the lockup agreement. D. Quiet period restrictions only apply to the issuer of new securities. E. A TV interview with a firm's CFO could cause a forced delay in the firm's IPO.

42. An individual investor with a small portfolio who wishes to purchase 100 shares of each IPO is more likely to receive an allocation of shares when: A. an IPO is substantially oversubscribed than when it is not. B. the knowledgeable investors feel the issue is underpriced. C. an IPO is severely underpriced. D. an IPO is undersubscribed. E. he or she has a standing order with the underwriter to purchase shares in every IPO handled by that underwriter.

43. When a firm announces an upcoming seasoned stock offering, the market price of the firm's existing shares tends to: A. increase. B. decrease. C. remain constant. D. respond but the direction of the response is not predictable as shown by past studies. E. decrease momentarily and then immediately increase substantially within an hour following the announcement.

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44. The total direct costs of underwriting an equity IPO: A. tends to increase on a percentage basis as the proceeds of the IPO increase. B. is generally between 7 and 8 percent, regardless of the issue size. C. can be as high as 25 percent for small issues. D. excludes the gross spread. E. excludes both the gross spread and the underpricing cost.

45. Which one of the following statements is correct concerning the costs of issuing securities? A. Domestic bonds are generally more expensive to issue than equity IPOs. B. Abnormal returns are rarely associated with seasoned issues. C. A seasoned offering is typically more expensive on a percentage basis than an IPO. D. There tends to be substantial economies of scale when issuing securities. E. The costs of issuing convertible bonds tend to be less on a percentage basis than the costs of issuing straight debt.

46. Existing shareholders: A. may or may not have a preemptive right to newly issued shares. B. must purchase new shares whenever rights are issued. C. are prohibited from selling their rights. D. are generally well advised to let the rights they receive expire. E. can maintain their proportional ownership positions without exercising their rights.

47. To purchase shares in a rights offering, a shareholder generally just needs to: A. pay the subscription amount in cash. B. submit the required form along with the required number of rights. C. pay the difference between the market price of the stock and the subscription price. D. submit the required number of rights along with a payment for the underwriting fee. E. submit the required number of rights along with the subscription price.

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48. The value of a right depends upon: I. the number of rights required to purchase one new share. II. the market price of the security. III. the subscription price. IV. the price-earnings ratio of the stock. A. II and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV

49. Before a seasoned stock offering, you owned 7,500 shares of a firm that had 500,000 shares outstanding. After the seasoned offering, you still owned 7,500 shares but the number of shares outstanding rose to 625,000. Which one of the following terms best describes this situation? A. overallotment B. percentage ownership dilution C. Green Shoe D. Red herring E. abnormal event

50. Which one of the following statements concerning dilution is correct? A. Dilution of percentage ownership occurs whenever an investor participates in a rights offer. B. Market value dilution increases as the net present value of a project increases. C. Market value dilution occurs when the net present value of a project is negative. D. Neither book value dilution nor market value dilution has any direct bearing on individual shareholders. E. Book value dilution is the cause of market value dilution.

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51. Which one of the following statements is correct concerning the issuance of long-term debt? A. A direct long-term loan has to be registered with the SEC. B. Direct placement debt tends to have more restrictive covenants than publicly issued debt. C. Distribution costs are lower for public debt than for private debt. D. It is easier to renegotiate public debt than private debt. E. Wealthy individuals tend to dominate the private debt market.

52. Shelf registration allows a firm to register multiple issues at one time with the SEC and then sell those registered shares anytime during the subsequent: A. 3 months. B. 6 months. C. 180 days. D. 2 years. E. 5 years.

53. Aaron's Sailboats has decided to take the company public by offering a total of 120,000 shares of common stock to the public. The firm has hired an underwriter who arranges a full commitment underwriting and suggests an initial selling price of $28 a share with an 8.5 percent spread. As it turns out, the underwriters only sell 97,400 shares. How much cash will Aaron's Sailboats receive from its first public offering? A. $2,727,200 B. $2,495,388 C. $3,074,400 D. $3,360,000 E. $3,645,600

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54. Nelson Paints recently went public by offering 65,000 shares of common stock to the public. The underwriters provided their services in a best efforts underwriting. The offering price was set at $16 a share and the gross spread was $2. After completing their sales efforts, the underwriters determined that they sold a total of 57,500 shares. How much cash did Nelson Paints receive from its IPO? A. $805,000 B. $910,000 C. $920,000 D. $1,035,000 E. $1,040,000

55. Miller Motors has decided to sell 1,600 shares of stock through a Dutch auction. The bids received are as follows:

How much will Miller Motors receive in total from selling the 1,600 shares? Ignore all transaction and flotation costs. A. $30,400 B. $33,400 C. $33,600 D. $35,400 E. $38,600

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56. Bakers' Town Bread is selling 1,200 shares of stock through a Dutch auction. The bids received are as follows:

How much cash will Bakers' Town Bread receive from selling these shares of stock? Ignore all transaction and flotation costs. A. $10,800 B. $12,000 C. $13,400 D. $14,400 E. $16,800

57. Webster Electrics is offering 1,500 shares of stock in a Dutch auction. The bids include:

How much cash will Webster Electrics receive from selling these shares? Ignore all transaction and flotation costs. A. $28,500 B. $30,000 C. $31,500 D. $33,000 E. $34,500

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58. You are a broker and have been instructed to place an order for a client to purchase 500 shares of every IPO that comes to market. The next two IPOs are each priced at $25 a share and will begin trading on the same day. The client is allocated 500 shares of IPO A and 100 shares of IPO B. At the end of the first day of trading, IPO A was selling for $23.50 a share and IPO B was selling for $29 a share. What is the client's total profit or loss on these two IPOs as of the end of the first day of trading? A. -$425 B. -$350 C. $525 D. $975 E. $1,150

59. Richard has an outstanding order with his stock broker to purchase 1,000 shares of every IPO. The next three IPOs are each priced at $30 a share and will all start trading on the same day. Richard is allocated 1,000 shares of IPO A, 400 shares of IPO B, and 100 shares of IPO C. On the first day of trading IPO A opened at $31.50 a share and ended the day at $26 a share. IPO B opened at $31 a share and finished the day at $32 a share. IPO C opened at $36.50 a share and ended the day at $40.25 a share. What is Richard's total profit or loss on these three IPOs as of the end of the first day of trading? A. -$2,175 B. -$1,850 C. -$1,500 D. $2,250 E. $3,500

60. Two IPOs will commence trading next week. Scott places an order to buy 300 shares of IPO A. Steve places an order to purchase 300 shares of IPO A and 300 shares of IPO B. Both IPOs are priced at $20 a share. Scott is allocated 100 shares of IPO A. Steve is allocated 100 shares of IPO A and 300 shares of IPO B. At the end of the first day of trading, IPO A is selling for $22.70 a share and IPO B is selling for $18.60 a share. What is the difference in the total profits or losses that Scott and Steve have as of the end of the first day of trading? A. $120 B. $240 C. $360 D. $420 E. $580

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61. Wear Ever is expanding and needs $12.6 million to help fund this growth. The firm estimates it can sell new shares of stock for $32.50 a share. It also estimates it will cost an additional $340,000 for filing and legal fees related to the stock issue. The underwriters have agreed to a 7.5 percent spread. How many shares of stock must Wear Ever sell if it is going to have $12.6 million available for its expansion needs? A. 370,376 shares B. 419,127 shares C. 430,437 shares D. 454,209 shares E. 461,806 shares

62. Mountain Teas wants to raise $11.6 million to open a new production center. The company estimates the issue costs including the legal and accounting fees will be $440,000. The underwriters have set the stock price at $17.50 a share and the underwriting spread at 9 percent. How many shares of stock does Mountain Teas have to sell to meet its cash need? A. 728,414 shares B. 756,044 shares C. 769,315 shares D. 772,200 shares E. 781,909 shares

63. Outdoor Living needs $7.5 million to finance modifications to its production equipment because the design of its all-season tents has changed dramatically. The underwriters estimate that the firm could sell additional shares of stock at $14.50 a share with a 7.5 percent underwriting spread. This would be a firm commitment underwriting. The estimated issue costs are $121,000. How many shares of stock will Outdoor Living need to sell to finance this project? A. 568,201 shares B. 488,917 shares C. 452,311 shares D. 559,180 shares E. 562,400 shares

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64. High Mountain Mining wants to expand its current operations and requires $3.5 million in additional funding to do so. After discussing this with key shareholders, the firm has decided to raise the necessary funds through a rights offering at a subscription price of $18 a share. The current market price of the firm's stock is $22 a share. How many shares of stock will the firm need to sell through the rights offering to fund the expansion plans? A. 140,015 shares B. 159,091 shares C. 166,667 shares D. 194,444 shares E. 205,688 shares

65. Northwest Rail wants to raise $14.2 million through a rights offering so it can purchase additional rail cars and upgrade its maintenance facilities. How many shares of stock will the firm need to sell through this offering if the current market price is $34 a share and the subscription price is $28 a share? A. 417,647 shares B. 437,856 shares C. 458,065 shares D. 482,604 shares E. 507,143 shares

66. A.K. Stevenson wants to raise $7.5 million through a rights offering. The subscription price is set at $24. Currently, the company has 2.1 million shares outstanding with a current market price of $25 a share. Each shareholder will receive one right for each share of stock they currently own. How many rights will be needed to purchase one new share of stock in this offering? A. 6.40 rights B. 6.67 rights C. 6.72 rights D. 6.87 rights E. 7.00 rights

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67. The Motor Plant wants to raise $21.4 million through a rights offering so it can modernize its facilities. The subscription price for the offering is set at $12 a share. Currently, the company has 2.6 million shares of stock outstanding at a market price of $12.50 a share. Each shareholder will receive one right for each share of stock they own. How many rights will a shareholder need to purchase one new share of stock in this offering? A. 1.46 rights B. 1.52 rights C. 1.55 rights D. 1.60 rights E. 1.67 rights

68. Miller Fruit wants to expand its citrus grove operations. The firm estimates that it needs $8.6 million to buy land and establish its operations. Currently, the firm has 540,000 shares of stock outstanding at a market price per share of $34.80. If the firm decides to raise the needed capital through a rights offering, one right will be issued for each share of stock. The subscription price will be set at $33 a share. How many rights will a shareholder need to purchase one new share of stock in this offering? A. 2.07 rights B. 2.17 rights C. 2.22 rights D. 2.50 rights E. 2.67 rights

69. Jefferson Refining is issuing a rights offering wherein every shareholder will receive one right for each share of stock they own. The new shares in this offering are priced at $21 plus 3 rights. The current market price of the stock is $23 a share. What is the value of one right? A. $0.25 B. $0.50 C. $1.00 D. $1.50 E. $2.00

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70. The stock of Cleaner Home Products is currently selling for $26.40 a share. The company has decided to raise funds through a rights offering wherein every shareholder will receive one right for each share of stock they own. The new shares being offered are priced at $25 plus five rights. What is the value of one right? A. $0.16 B. $0.23 C. $0.25 D. $0.47 E. $0.50

71. Barstow Industrial Supply has decided to raise $27.52 million in additional funding via a rights offering. The firm will issue one right for each share of stock outstanding. The offering consists of a total of 860,000 new shares. The current market price of the stock is $35. Currently, there are 5.16 million shares outstanding. What is the value of one right? A. $0.37 B. $0.43 C. $0.48 D. $0.52 E. $0.60

72. You currently own 8 percent of the 3.5 million outstanding shares of Webster Mills. The company has just announced a rights offering with a subscription price of $28. One right will be issued for each share of outstanding stock. This offering will provided $9 million of new financing for the firm, ignoring all issue costs. Assume that all rights are exercised. What will be your new ownership position if you opted to sell your rights rather than exercise them personally? A. 7.33 percent B. 7.46 percent C. 7.87 percent D. 8.00 percent E. 8.21 percent

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73. Jennifer owns 12,000 shares of Calico Clothing. Currently, there are 1.6 million shares of stock outstanding. The company has just announced a rights offering whereby 200,000 shares are being offered for sale at a subscription price of $14 a share. The current stock price is $16 a share. Assume that Jennifer sells her rights and that all rights are exercised. What percentage of the firm will Jennifer own after the rights offering? A. 0.67 percent B. 0.75 percent C. 0.86 percent D. 0.93 percent E. 1.01 percent

74. Underwater Experimental is considering a project which requires the purchase of $498,000 of fixed assets. The net present value of the project is $22,500. Equity shares will be issued as the sole means of financing the project. What will the new book value per share be after the project is implemented given the following current information on the firm?

A. $13.25 B. $13.70 C. $14.23 D. $14.94 E. $15.60

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75. Birds and More is considering a project which requires the purchase of $164,000 of fixed assets. The net present value of the project is $4,500. Equity shares will be issued as the sole means of financing this project. The price-earnings ratio of the project equals that of the existing firm. What will the new market value per share be after the project is implemented given the following current information on the firm?

A. $20.68 B. $20.72 C. $20.80 D. $20.95 E. $21.10

76. Wagner Trucking is considering investing in a new project that will cost $13 million and increase net income by 6.5 percent. This project will be completely funded by issuing new equity shares. Currently, the firm has 1.25 million shares of stock outstanding with a market price of $42 per share. The current earnings per share are $1.82. What will the earnings per share be if the project is implemented? A. $1.39 B. $1.45 C. $1.55 D. $1.62 E. $1.69

77. You own 15 percent or 13,500 shares of Printers, Etc. These shares have a total market value of $426,600. By what percentage will the total value of your investment in this firm change if the company sells an additional 10,000 shares of stock at $30 a share and you do not buy any? A. -1.37 percent B. -1.21 percent C. -0.51 percent D. 1.03 percent E. 1.29 percent

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78. Kurt currently owns 3.4 percent of Northeastern Transportation. The company has a total of 438,000 shares outstanding with a current market price of $26.20 a share. At present, the firm is offering an additional 25,000 shares at a price of $25 a share. Kurt decides not to participate in this offering. What will his ownership position be after the offering is completed? A. 3.06 percent B. 3.22 percent C. 3.27 percent D. 3.40 percent E. 3.51 percent

Essay Questions

79. It can be argued that the decision to accept venture capital is one of the most critical decisions an entrepreneur must make. Explain why.

80. Explain both a rights offering and the basic characteristics of a right.

81. Explain why there is a tendency for IPOs to be underpriced.

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82. Firms encounter several costs when issuing new securities. Identify and describe at least four of these costs.

83. Steve is the founder of Jefferson & Westover. Recently, the firm decided to issue an IPO with Steve retaining 30 percent ownership of the firm. The IPO agreement contained both a Green Shoe provision and a 6-month lockup agreement. Steve's cost basis per share is $15. The offering price for the IPO was $16. On the first day of trading, the market price per share rose to $28.20 and closed for the day at $25.60. Now, six months after the IPO release, the stock is valued at $15.40 a share. Explain who benefited the most during the lockup period, an outside investor or Steve, and why.

Multiple Choice Questions

84. The Timken Company has announced a rights offer to raise $25 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a nonrefundable reviewing fee of $2,500 per page. The stock currently sells for $48 per share, and there are 2.6 million shares outstanding. The subscription price is set at $43 per share. What is the ex-rights price per share? A. $45.58 B. $47.09 C. $48.15 D. $48.80 E. $49.42

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85. The Warm Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share price will fall from $100 to $95 ($100 is the rights-on-price; $95 is the ex-rights price, also known as the whenissued price). The company is seeking $18 million in additional funds with a per-share subscription price of $50. How many shares of stock are outstanding, before the offering? (Assume that the increment to the market value of the equity equals the gross proceeds of the offering.) A. 324,000 B. 360,000 C. 1,800,000 D. 3,240,000 E. 3,600,000

86. The Woods Co. and the Mickelson Co. have both announced IPOs at $43 per share. One of these is undervalued by $20, and the over is overvalued by $14, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. What is the amount of the difference between your expected profit and the amount of profit you could earn if you could get 1,000 shares of Woods and 1,000 shares of Mickelson? A. -$10,000 B. -$6,000 C. -$4,000 D. $4,000 E. $6,000

87. Flagler, Inc. needs to raise $30 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. The offer price is $30 per share and the company's underwriters charge a 10 percent spread. How many shares need to be sold? A. 1,111,111 shares B. 1,250,000 shares C. 1,666,667 shares D. 2,500,000 shares E. 3,333,333 shares

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88. The Educated Horses Corporation needs to raise $20 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. Suppose the offer price is $40 per share and the company's underwriters charge an 8 percent spread. The SEC filing fee and associated administrative expenses of the offering are $660,000. How many shares need to be sold? A. 448,907 B. 461,222 C. 511,111 D. 529,937 E. 561,413

89. The Huff Co. has just gone public. Under a firm commitment agreement, Huff received $21.50 for each of the 6 million shares sold. The initial offering price was $23.65 per share, and the stock rose to $30.51 per share in the first few minutes of trading. Huff paid $1,260,000 in direct legal and other costs, and $390,000 in indirect costs. The flotation costs were what percentage of the funds raised? A. 38.56 percent B. 40.32 percent C. 41.68 percent D. 43.75 percent E. 44.09 percent

90. Mountain Homes wishes to expand its facilities. The company currently has 7 million shares outstanding and no debt. The stock sells for $55 per share, but the book value per share is $43. The firm's net income is currently $9.1 million. The new facility will cost $30 million, and it will increase net income by $309,000. Assume the firm issues new equity to fund this expansion while maintaining a constant price-earnings ratio. What will be the EPS be after the new equity issue? A. $1.25 B. $1.30 C. $1.35 D. $1.40 E. $1.45

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91. The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:

MHMM is considering an investment that has the same P/E ratio as the firm. The cost of the investment is $798,270, and it will be financed with a new equity issue. What would the ROE on the investment have to be if we wanted the price after the offering to be $110 per share? Assume the PE ratio remains constant. A. 18.28 percent B. 21.41 percent C. 27.63 percent D. 37.27 percent E. 40.03 percent

92. Precise Machining is considering a rights offer. The company has determined that the exrights price would be $46. The current price is $53 per share, and there are 7 million shares outstanding. The rights offer would raise a total of $70 million. What is the subscription price? A. $26.48 B. $27.06 C. $27.50 D. $28.18 E. $29.10

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93. Atlas Corp. wants to raise $4 million via a rights offering. The company currently has 450,000 shares of common stock outstanding that sell for $40 per share. Its underwriter has set a subscription price of $26 per share and will charge the company a 7 percent spread. Assume that you currently own 7,200 shares of stock in the company and decide not to participate in the rights offering. How much can you get for selling all of your rights? A. $24,911.21 B. $25,362.84 C. $25,792.19 D. $26,414.14 E. $27,094.95

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Chapter 15 Raising Capital Answer Key

Multiple Choice Questions

1. Jones & Co. is funded by a group of individual investors for the sole purpose of providing funding for individuals who are trying to convert their new ideas into viable products. What is this type of funding called? A. green shoe funding B. tombstone underwriting C. venture capital D. red herring funding E. life cycle capital Refer to section 15.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Venture capital

2. What is the form called that is filed with the SEC and discloses the material information on a securities issuer when that issuer offers new securities to the general public? A. prospectus B. red herring C. indenture D. public disclosure statement E. registration statement Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: Registration statement

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3. Miller & Chase is offering $4 million of new securities to the general public. Which SEC regulation governs this offering? A. Regulation A B. Regulation C C. Regulation G D. Regulation Q E. Regulation R Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: Regulation A

4. What is a prospectus? A. a letter issued by the SEC authorizing a new issue of securities B. a report stating that the SEC recommends a new security to investors C. a letter issued by the SEC that outlines the changes required for a registration statement to be approved D. a document that describes the details of a proposed security offering along with relevant information about the issuer E. an advertisement in a financial newspaper that describes a security offering Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: Prospectus

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5. Which one of the following is a preliminary prospectus? A. tombstone B. green shoe C. registration statement D. rights offer E. red herring Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: Red herring

6. Advertisements in a financial newspaper announcing a public offering of securities, along with a list of the investment banks handling the offering, are called: A. red herrings. B. tombstones. C. Green Shoes. D. registration statements. E. cash offers. Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: Tombstones

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7. What is an issue of securities that is offered for sale to the general public on a direct cash basis called? A. best efforts underwriting B. firm commitment underwriting C. general cash offer D. rights offer E. herring offer Refer to section 15.3

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.3 Topic: General cash offer

8. Tony currently owns 12,000 shares of GL Tools. He has just been notified that the firm is issuing additional shares of stock and that he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called? A. best efforts offer B. firm commitment offer C. general cash offer D. rights offer E. priority offer Refer to section 15.3

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.3 Topic: Rights offer

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9. Soup Galore is a partnership that was formed three years ago for the purpose of creating, producing, and distributing healthy soups in a dried form. The firm has been extremely successful thus far and has decided to incorporate and offer shares of stock to the general public. What is this type of an equity offering called? A. venture capital offering B. shelf offering C. private placement D. seasoned equity offering E. initial public offering Refer to section 15.3

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-3 Section: 15.3 Topic: Initial public offering

10. What is a seasoned equity offering? A. an offering of shares by shareholders for repurchase by the issuer B. shares of stock that have been recommended for purchase by the SEC C. equity securities held by a firm's founder that are being offered for sale to the general public D. sale of newly issued equity shares by a firm that is currently publicly owned E. a set number of equity shares that are issued and offered to the public annually Refer to section 15.3

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.3 Topic: Seasoned equity offering

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11. Executive Tours has decided to take its firm public and has hired an investment firm to handle this offering. The investment firm is serving as a(n): A. aftermarket specialist. B. venture capitalist. C. underwriter. D. seasoned writer. E. primary investor. Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Underwriters

12. What is the definition of a syndicate? A. a venture capitalist B. a group of attorneys providing services for an IPO C. block of investors who control a firm D. a bank that loans funds to finance the start-up of a new firm E. a group of underwriters sharing the risk of selling a new issue of securities Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Syndicate

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13. The difference between the underwriters' cost of buying shares in a firm commitment and the offering price of those securities to the public is called the: A. gross spread. B. under price amount C. filing fee. D. new issue premium. E. offer price. Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Gross spread

14. D.L. Jones & Co. recently went public. The firm received $20.80 a share on the entire offer of 25,000 shares. Keeser & Co. served as the underwriter and sold 23,700 shares to the public at an offer price of $22 a share. What type of underwriting was this? A. best efforts B. shelf C. over subscribed D. private placement E. firm commitment Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Firm commitment

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15. Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public. The underwriters charged a fee of 8 percent and paid Blue Stone Builders $16.40 a share on 40,000 shares. Which one of the following terms best describes this underwriting? A. best efforts B. shelf C. direct rights D. private placement E. firm commitment Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Best efforts

16. The 40-day period following an IPO during which the SEC places restrictions on the public communications of the issuer is known as the _____ period. A. silent B. quiet C. lockup D. green E. red Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Quiet period

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17. Denver Liquid Wholesalers recently offered 50,000 new shares of stock for sale. The underwriters sold a total of 53,000 shares to the public. The additional 3,000 shares were purchased in accordance with which one of the following? A. Green shoe provision B. Red herring provision C. quiet provision D. lockup agreement E. post-issue agreement Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Green shoe provision

18. Shares of PLS United have been selling with rights attached. Tomorrow, the stock will sell independent of these rights. Which one of the following terms applies to tomorrow in relation to this stock? A. pre-issue date B. aftermarket date C. declaration date D. holder-of-record date E. ex-rights date Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Ex-rights date

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19. The date on which a shareholder is officially listed as the recipient of stock rights is called the: A. issue date. B. offer date C. declaration date D. holder-of-record date. E. ex-rights date. Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Holder-of-record date

20. A rights offering in which an underwriting syndicate agrees to purchase the unsubscribed portion of an issue is called a _____ underwriting. A. standby B. best efforts C. firm commitment D. direct fee E. tombstone Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Standby underwriting

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21. The amount paid to an underwriter who participates in a standby underwriting agreement is called a(n): A. gross spread. B. optional spread. C. standby fee. D. additional fee. E. oversubscription fee. Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Standby fee

22. Franklin Minerals recently had a rights offering of 1,000 shares at an offer price of $10 a share. Isabelle is a shareholder who exercised her rights option by buying all of the rights to which she was entitled based on the number of shares she owns. Currently, there are six shareholders who have opted not to participate in the rights offering. Isabelle would like to purchase the unsubscribed shares. Which one of the following will allow her to do so? A. standby provision B. oversubscription privilege C. open offer privilege D. new issues provision E. overallotment provision Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Oversubscription privilege

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23. Roy owns 200 shares of R.T.F., Inc. He has opted not to participate in the current rights offering by this firm. As a result, Roy will most likely be subject to: A. an oversubscription cost. B. underpricing. C. dilution. D. the Green Shoe provision. E. a locked in period. Refer to section 15.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.9 Topic: Dilution

24. Direct business loans typically ranging from one to five years are called: A. private placements. B. debt SEOs. C. notes payable. D. debt IPOs. E. term loans. Refer to section 15.10

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.10 Topic: Term loans

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Chapter 15 - Raising Capital

25. A group of five private investors recently loaned $6 million to Henderson Hardware for ten years at 9 percent interest. This loan is best described as a: A. private placement. B. debt SEO. C. notes payable. D. debt IPO. E. term loan. Refer to section 15.10

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.10 Topic: Private placement

26. Pearson Electric recently registered 250,000 shares of stock under SEC Rule 415. The firm plans to sell 150,000 shares this year and the remaining 100,000 shares next year. What type of registration was this? A. standby registration B. shelf registration C. Regulation A registration D. Regulation Q registration E. private placement registration Refer to section 15.11

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.11 Topic: Shelf registration

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27. Suzie is a chemist who has been experimenting with fragrances in her home laboratory and feels that she now has three viable perfumes that could be successfully marketed. She knows a venture capitalist who has offered to finance her business to the point where she would be ready to begin the manufacturing and marketing stage. Which type of financing is Suzie being offered? A. syndicate B. introduction C. second-stage D. mezzanine-level E. seed money Refer to section 15.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Seed money

28. Which one of the following is probably the most successful means of finding venture capital? A. internet searches B. Dutch auctions C. newspaper advertisements D. personal contacts E. personal letters to venture capital firms Refer to section 15.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Venture capital

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29. Which one of the following statements concerning venture capital financing is correct? A. Venture capitalists desire shares of common stock but avoid preferred stock. B. Venture capital is relatively easy to obtain. C. Venture capitalists rarely assume active roles in the management of the financed firm. D. Venture capitalists often require at least a forty percent equity position as a condition of financing. E. Venture capital is relatively inexpensive in today's competitive markets. Refer to section 15.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Venture capital

30. Which one of the following statements concerning venture capitalists is correct? A. Venture capitalists assume management responsibility for the firms they finance. B. Exit strategy is a key consideration when selecting a venture capitalist. C. Venture capitalists limit their services to providing money to start-up firms. D. Most venture capitalists are long-term investors in a firm. E. A venture capitalist normally invests in a new idea and finances that idea until the newlyformed firm can issue an IPO. Refer to section 15.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Venture capital

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31. Which of the following should be considered when selecting a venture capitalist? I. level of involvement II. past experiences III. termination of funding IV. financial strength A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and IV only E. I, II, III, and IV Refer to section 15.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Venture capital

32. Trevor is the CEO of Harvest Foods, which is a privately-held corporation. What is the first step he must take if he wishes to take Harvest Foods public? A. select an underwriter B. obtain SEC approval C. gain board approval D. prepare a registration statement E. distribute a prospectus Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 and 15-3 Section: 15.2 Topic: IPO

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Chapter 15 - Raising Capital

33. All new interstate security issues are regulated by the: A. registration statement. B. Green Shoe provision. C. Securities Exchange Act of 1934. D. Securities Act of 1933. E. Federal Reserve Act of 1931. Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: Securities Act of 1933

34. The Securities and Exchange Commission: A. verifies the accuracy of the information contained in the prospectus. B. verifies the accuracy of the information contained in the red herring. C. examines the registration statement during the Green Shoe period. D. is concerned only that an issue complies with all rules and regulations. E. determines the final offer price once they have approved the registration statement. Refer to section 15.2

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.2 Topic: SEC

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35. Underwriters generally: A. pay a spread to the issuing firm. B. provide only best efforts underwriting in the U.S. C. receive less compensation under a competitive agreement than under a negotiated agreement. D. market and distribute an entire issue of new securities within their own firm. E. pass the risk of unsold shares back to the issuing firm via a firm commitment agreement. Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Underwriters

36. With firm commitment underwriting, the issuing firm: A. is unsure of the total amount of funds it will receive until after the offering is completed. B. is unsure of the number of shares it will actually issue until after the offering is completed. C. knows exactly how many shares will be purchased by the general public during the offer period. D. retains the financial risk associated with unsold shares. E. knows up-front the amount of money it will receive from the stock offering. Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Firm commitment underwriting

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Chapter 15 - Raising Capital

37. With Dutch auction underwriting: A. each winning bidder pays the price he or she bid. B. all successful bidders pay the same price. C. all bidders receive at least a portion of the quantity for which they bid. D. the selling firm receives the maximum possible price for each security sold. E. the bidder for the largest quantity receives the first allocation of securities. Refer to section 15.4

AACSB: N/A Bloom's: Comprehension Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Dutch auction

38. If an IPO is underpriced then the: A. investors in the IPO are generally unhappy with the underwriters. B. issue is less likely to sell out. C. stock price will generally decline on the first day of trading. D. issuing firm is guaranteed to be successful in the long term. E. issuing firm receives less money than it probably should have. Refer to section 15.5

AACSB: N/A Bloom's: Comprehension Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO underpricing

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39. Which of the following have been offered as supporting arguments in favor of IPO underpricing? I. Underpricing counteracts the "winner's curse". II. Underpricing rewards institutional investors for sharing their opinions of a stock's market value. III. Underpricing diminishes the underwriting risk of a firm commitment underwriting. IV. Underpricing reduces the probability that investors will sue the underwriters. A. I and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV Refer to section 15.5

AACSB: N/A Bloom's: Comprehension Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO underpricing

40. Which one of the following is a key goal of the aftermarket period? A. collection of largest number of Dutch auction bids as possible B. best determination of a fair offer price for an upcoming IPO C. price support for a new issue of securities D. establishment of a broad-based underwriting syndicate for an upcoming IPO E. widest distribution of red herrings as possible Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-3 Section: 15.4 Topic: Aftermarket period

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41. Which one of the following statements is correct? A. The quiet period commences when a registration statement is filed with the SEC and ends on the day the IPO shares commence trading. B. Lockup agreements outline how oversubscribed IPO shares will be allocated. C. Additional IPO shares can be issued in accordance with the lockup agreement. D. Quiet period restrictions only apply to the issuer of new securities. E. A TV interview with a firm's CFO could cause a forced delay in the firm's IPO. Refer to section 15.4

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-3 Section: 15.4 Topic: IPO provisions

42. An individual investor with a small portfolio who wishes to purchase 100 shares of each IPO is more likely to receive an allocation of shares when: A. an IPO is substantially oversubscribed than when it is not. B. the knowledgeable investors feel the issue is underpriced. C. an IPO is severely underpriced. D. an IPO is undersubscribed. E. he or she has a standing order with the underwriter to purchase shares in every IPO handled by that underwriter. Refer to section 15.5

AACSB: N/A Bloom's: Comprehension Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO allocations

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Chapter 15 - Raising Capital

43. When a firm announces an upcoming seasoned stock offering, the market price of the firm's existing shares tends to: A. increase. B. decrease. C. remain constant. D. respond but the direction of the response is not predictable as shown by past studies. E. decrease momentarily and then immediately increase substantially within an hour following the announcement. Refer to section 15.6

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.6 Topic: Stock issue announcement

44. The total direct costs of underwriting an equity IPO: A. tends to increase on a percentage basis as the proceeds of the IPO increase. B. is generally between 7 and 8 percent, regardless of the issue size. C. can be as high as 25 percent for small issues. D. excludes the gross spread. E. excludes both the gross spread and the underpricing cost. Refer to section 15.7

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Issue costs

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45. Which one of the following statements is correct concerning the costs of issuing securities? A. Domestic bonds are generally more expensive to issue than equity IPOs. B. Abnormal returns are rarely associated with seasoned issues. C. A seasoned offering is typically more expensive on a percentage basis than an IPO. D. There tends to be substantial economies of scale when issuing securities. E. The costs of issuing convertible bonds tend to be less on a percentage basis than the costs of issuing straight debt. Refer to section 15.7

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Issue costs

46. Existing shareholders: A. may or may not have a preemptive right to newly issued shares. B. must purchase new shares whenever rights are issued. C. are prohibited from selling their rights. D. are generally well advised to let the rights they receive expire. E. can maintain their proportional ownership positions without exercising their rights. Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights

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47. To purchase shares in a rights offering, a shareholder generally just needs to: A. pay the subscription amount in cash. B. submit the required form along with the required number of rights. C. pay the difference between the market price of the stock and the subscription price. D. submit the required number of rights along with a payment for the underwriting fee. E. submit the required number of rights along with the subscription price. Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights

48. The value of a right depends upon: I. the number of rights required to purchase one new share. II. the market price of the security. III. the subscription price. IV. the price-earnings ratio of the stock. A. II and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV Refer to section 15.8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights

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49. Before a seasoned stock offering, you owned 7,500 shares of a firm that had 500,000 shares outstanding. After the seasoned offering, you still owned 7,500 shares but the number of shares outstanding rose to 625,000. Which one of the following terms best describes this situation? A. overallotment B. percentage ownership dilution C. Green Shoe D. Red herring E. abnormal event Refer to section 15.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.9 Topic: Dilution

50. Which one of the following statements concerning dilution is correct? A. Dilution of percentage ownership occurs whenever an investor participates in a rights offer. B. Market value dilution increases as the net present value of a project increases. C. Market value dilution occurs when the net present value of a project is negative. D. Neither book value dilution nor market value dilution has any direct bearing on individual shareholders. E. Book value dilution is the cause of market value dilution. Refer to section 15.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-4 Section: 15.9 Topic: Dilution

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Chapter 15 - Raising Capital

51. Which one of the following statements is correct concerning the issuance of long-term debt? A. A direct long-term loan has to be registered with the SEC. B. Direct placement debt tends to have more restrictive covenants than publicly issued debt. C. Distribution costs are lower for public debt than for private debt. D. It is easier to renegotiate public debt than private debt. E. Wealthy individuals tend to dominate the private debt market. Refer to section 15.10

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.10 Topic: Long-term debt

52. Shelf registration allows a firm to register multiple issues at one time with the SEC and then sell those registered shares anytime during the subsequent: A. 3 months. B. 6 months. C. 180 days. D. 2 years. E. 5 years. Refer to section 15.11

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-2 Section: 15.11 Topic: Shelf registration

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Chapter 15 - Raising Capital

53. Aaron's Sailboats has decided to take the company public by offering a total of 120,000 shares of common stock to the public. The firm has hired an underwriter who arranges a full commitment underwriting and suggests an initial selling price of $28 a share with an 8.5 percent spread. As it turns out, the underwriters only sell 97,400 shares. How much cash will Aaron's Sailboats receive from its first public offering? A. $2,727,200 B. $2,495,388 C. $3,074,400 D. $3,360,000 E. $3,645,600 Total cash received = 120,000 × $28 (1 - 0.085) = $3,074,400

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Initial public offering

54. Nelson Paints recently went public by offering 65,000 shares of common stock to the public. The underwriters provided their services in a best efforts underwriting. The offering price was set at $16 a share and the gross spread was $2. After completing their sales efforts, the underwriters determined that they sold a total of 57,500 shares. How much cash did Nelson Paints receive from its IPO? A. $805,000 B. $910,000 C. $920,000 D. $1,035,000 E. $1,040,000 Total cash received = 57,500 × ($16 - $2) = $805,000

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Initial public offering

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Chapter 15 - Raising Capital

55. Miller Motors has decided to sell 1,600 shares of stock through a Dutch auction. The bids received are as follows:

How much will Miller Motors receive in total from selling the 1,600 shares? Ignore all transaction and flotation costs. A. $30,400 B. $33,400 C. $33,600 D. $35,400 E. $38,600 Total cash received = 1,600 × $21 = $33,600

AACSB: Analytic Bloom's: Analytic Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Dutch auction

15-57

Chapter 15 - Raising Capital

56. Bakers' Town Bread is selling 1,200 shares of stock through a Dutch auction. The bids received are as follows:

How much cash will Bakers' Town Bread receive from selling these shares of stock? Ignore all transaction and flotation costs. A. $10,800 B. $12,000 C. $13,400 D. $14,400 E. $16,800 Total cash received = 1,200 × $10 = $12,000

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Dutch auction

15-58

Chapter 15 - Raising Capital

57. Webster Electrics is offering 1,500 shares of stock in a Dutch auction. The bids include:

How much cash will Webster Electrics receive from selling these shares? Ignore all transaction and flotation costs. A. $28,500 B. $30,000 C. $31,500 D. $33,000 E. $34,500 Total cash received = 1,500 × $21 = $31,500

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-2 Section: 15.4 Topic: Dutch auction

15-59

Chapter 15 - Raising Capital

58. You are a broker and have been instructed to place an order for a client to purchase 500 shares of every IPO that comes to market. The next two IPOs are each priced at $25 a share and will begin trading on the same day. The client is allocated 500 shares of IPO A and 100 shares of IPO B. At the end of the first day of trading, IPO A was selling for $23.50 a share and IPO B was selling for $29 a share. What is the client's total profit or loss on these two IPOs as of the end of the first day of trading? A. -$425 B. -$350 C. $525 D. $975 E. $1,150 Total profit = [500 × ($23.50 - $25)] + [100 × ($29 - $25)] = -$350

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO

59. Richard has an outstanding order with his stock broker to purchase 1,000 shares of every IPO. The next three IPOs are each priced at $30 a share and will all start trading on the same day. Richard is allocated 1,000 shares of IPO A, 400 shares of IPO B, and 100 shares of IPO C. On the first day of trading IPO A opened at $31.50 a share and ended the day at $26 a share. IPO B opened at $31 a share and finished the day at $32 a share. IPO C opened at $36.50 a share and ended the day at $40.25 a share. What is Richard's total profit or loss on these three IPOs as of the end of the first day of trading? A. -$2,175 B. -$1,850 C. -$1,500 D. $2,250 E. $3,500 Total profit = [1,000 × ($26 - $30)] + [400 × ($32 - $30)] + [100 × ($40.25 - $30)] = -$2,175

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO

15-60

Chapter 15 - Raising Capital

60. Two IPOs will commence trading next week. Scott places an order to buy 300 shares of IPO A. Steve places an order to purchase 300 shares of IPO A and 300 shares of IPO B. Both IPOs are priced at $20 a share. Scott is allocated 100 shares of IPO A. Steve is allocated 100 shares of IPO A and 300 shares of IPO B. At the end of the first day of trading, IPO A is selling for $22.70 a share and IPO B is selling for $18.60 a share. What is the difference in the total profits or losses that Scott and Steve have as of the end of the first day of trading? A. $120 B. $240 C. $360 D. $420 E. $580 Scott's profit = 100 × ($22.70 - $20) = $270 Steve's profit = [100 × ($22.70 - $20)] + [300 × ($18.60 - $20)] = -$150 Difference = $270 - (-$150) = $420

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO

61. Wear Ever is expanding and needs $12.6 million to help fund this growth. The firm estimates it can sell new shares of stock for $32.50 a share. It also estimates it will cost an additional $340,000 for filing and legal fees related to the stock issue. The underwriters have agreed to a 7.5 percent spread. How many shares of stock must Wear Ever sell if it is going to have $12.6 million available for its expansion needs? A. 370,376 shares B. 419,127 shares C. 430,437 shares D. 454,209 shares E. 461,806 shares Total value of issue = ($12,600,000 + $340,000)/(1 - 0.075) = $13,989,189.19 Number of shares needed = $13,989,189.19/$32.50 = 430,437 shares

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Issue costs

15-61

Chapter 15 - Raising Capital

62. Mountain Teas wants to raise $11.6 million to open a new production center. The company estimates the issue costs including the legal and accounting fees will be $440,000. The underwriters have set the stock price at $17.50 a share and the underwriting spread at 9 percent. How many shares of stock does Mountain Teas have to sell to meet its cash need? A. 728,414 shares B. 756,044 shares C. 769,315 shares D. 772,200 shares E. 781,909 shares Total value of issue = ($11,600,000 + $440,000)/(1 - 0.09) = $13,230,769 Number of shares needed = $13,230,769/$17.50 = 756,044 shares

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Issue costs

63. Outdoor Living needs $7.5 million to finance modifications to its production equipment because the design of its all-season tents has changed dramatically. The underwriters estimate that the firm could sell additional shares of stock at $14.50 a share with a 7.5 percent underwriting spread. This would be a firm commitment underwriting. The estimated issue costs are $121,000. How many shares of stock will Outdoor Living need to sell to finance this project? A. 568,201 shares B. 488,917 shares C. 452,311 shares D. 559,180 shares E. 562,400 shares Total value of issue = ($7,500,000 + $121,000)/(1 - 0.075) = $8,238,918.92 Number of shares needed = $8,238,918.92/$14.50 = 568,201 shares

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Issue costs

15-62

Chapter 15 - Raising Capital

64. High Mountain Mining wants to expand its current operations and requires $3.5 million in additional funding to do so. After discussing this with key shareholders, the firm has decided to raise the necessary funds through a rights offering at a subscription price of $18 a share. The current market price of the firm's stock is $22 a share. How many shares of stock will the firm need to sell through the rights offering to fund the expansion plans? A. 140,015 shares B. 159,091 shares C. 166,667 shares D. 194,444 shares E. 205,688 shares $3.5m/$18 = 194,444 shares

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

65. Northwest Rail wants to raise $14.2 million through a rights offering so it can purchase additional rail cars and upgrade its maintenance facilities. How many shares of stock will the firm need to sell through this offering if the current market price is $34 a share and the subscription price is $28 a share? A. 417,647 shares B. 437,856 shares C. 458,065 shares D. 482,604 shares E. 507,143 shares $14.2m/$28 = 507,143 shares

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

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Chapter 15 - Raising Capital

66. A.K. Stevenson wants to raise $7.5 million through a rights offering. The subscription price is set at $24. Currently, the company has 2.1 million shares outstanding with a current market price of $25 a share. Each shareholder will receive one right for each share of stock they currently own. How many rights will be needed to purchase one new share of stock in this offering? A. 6.40 rights B. 6.67 rights C. 6.72 rights D. 6.87 rights E. 7.00 rights Number of rights issued = 1 × 2.1m = 2.1m; Number of shares needed = $7.5m/$24 = 312,500; Rights needed for each new share = 2.1m/312,500 = 6.72 rights

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

67. The Motor Plant wants to raise $21.4 million through a rights offering so it can modernize its facilities. The subscription price for the offering is set at $12 a share. Currently, the company has 2.6 million shares of stock outstanding at a market price of $12.50 a share. Each shareholder will receive one right for each share of stock they own. How many rights will a shareholder need to purchase one new share of stock in this offering? A. 1.46 rights B. 1.52 rights C. 1.55 rights D. 1.60 rights E. 1.67 rights Number of rights issued = 1 × 2.6m = 2.6m; Number of shares needed = $21.4m/$12 = 1,783,333.33; Rights needed for each new share = 2.6m/1,783,333.33 = 1.46 rights

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

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Chapter 15 - Raising Capital

68. Miller Fruit wants to expand its citrus grove operations. The firm estimates that it needs $8.6 million to buy land and establish its operations. Currently, the firm has 540,000 shares of stock outstanding at a market price per share of $34.80. If the firm decides to raise the needed capital through a rights offering, one right will be issued for each share of stock. The subscription price will be set at $33 a share. How many rights will a shareholder need to purchase one new share of stock in this offering? A. 2.07 rights B. 2.17 rights C. 2.22 rights D. 2.50 rights E. 2.67 rights Number of rights issued = 1 × 540,000 = 540,000; Number of shares needed = $8.6m/$33 = 260,606.06; Rights needed for each new share = 540,000/260,606.06 = 2.07 rights

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

69. Jefferson Refining is issuing a rights offering wherein every shareholder will receive one right for each share of stock they own. The new shares in this offering are priced at $21 plus 3 rights. The current market price of the stock is $23 a share. What is the value of one right? A. $0.25 B. $0.50 C. $1.00 D. $1.50 E. $2.00 Value per share excluding right = [$21 + (3 × $23)]/(1 + 3) = $22.50 Value of one right = $23 - $22.50 = $0.50

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Right value

15-65

Chapter 15 - Raising Capital

70. The stock of Cleaner Home Products is currently selling for $26.40 a share. The company has decided to raise funds through a rights offering wherein every shareholder will receive one right for each share of stock they own. The new shares being offered are priced at $25 plus five rights. What is the value of one right? A. $0.16 B. $0.23 C. $0.25 D. $0.47 E. $0.50 Cost per share = [$25 + (5 × $26.40)]/(1 + 5) = $26.17 Value of right = $26.40 - $26.17 = $0.23

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Right value

71. Barstow Industrial Supply has decided to raise $27.52 million in additional funding via a rights offering. The firm will issue one right for each share of stock outstanding. The offering consists of a total of 860,000 new shares. The current market price of the stock is $35. Currently, there are 5.16 million shares outstanding. What is the value of one right? A. $0.37 B. $0.43 C. $0.48 D. $0.52 E. $0.60 Subscription price = $27.52m/860,000 shares = $32 a share Number of shares issued = 1 × 5.16m = 5.16m Number of rights needed = 5.16m/860,000 = 6 Cost per share = [$32 + (6 × $35)]/(1 + 6) = $34.57 Value of a right = $35 - $34.57 = $0.43

AACSB: Analytic Bloom's: Application Difficulty: Intermediate Learning Objective: 15-4 Section: 15.8 Topic: Right value

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Chapter 15 - Raising Capital

72. You currently own 8 percent of the 3.5 million outstanding shares of Webster Mills. The company has just announced a rights offering with a subscription price of $28. One right will be issued for each share of outstanding stock. This offering will provided $9 million of new financing for the firm, ignoring all issue costs. Assume that all rights are exercised. What will be your new ownership position if you opted to sell your rights rather than exercise them personally? A. 7.33 percent B. 7.46 percent C. 7.87 percent D. 8.00 percent E. 8.21 percent Number of shares owned = 0.08 × 3.5m = 280,000 shares Number of shares offered = $9m/$28 = 321,428.57 shares New ownership position = 280,000/(3.5m + 321,428.57) = 7.33 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.9 Topic: Dilution

73. Jennifer owns 12,000 shares of Calico Clothing. Currently, there are 1.6 million shares of stock outstanding. The company has just announced a rights offering whereby 200,000 shares are being offered for sale at a subscription price of $14 a share. The current stock price is $16 a share. Assume that Jennifer sells her rights and that all rights are exercised. What percentage of the firm will Jennifer own after the rights offering? A. 0.67 percent B. 0.75 percent C. 0.86 percent D. 0.93 percent E. 1.01 percent New ownership percentage = 12,000/(1.6m + 0.2m) = 0.67 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-4 Section: 15.9 Topic: Dilution

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Chapter 15 - Raising Capital

74. Underwater Experimental is considering a project which requires the purchase of $498,000 of fixed assets. The net present value of the project is $22,500. Equity shares will be issued as the sole means of financing the project. What will the new book value per share be after the project is implemented given the following current information on the firm?

A. $13.25 B. $13.70 C. $14.23 D. $14.94 E. $15.60 Current market value per share = $936,000/60,000 = $15.60 Number of new shares needed = $498,000/$15.60 = 31,923.08 shares New book value per share = ($720,000 + $498,000)/(60,000 + 31,923.08) = $13.25

AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate Learning Objective: 15-3 Section: 15.9 Topic: Book value

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Chapter 15 - Raising Capital

75. Birds and More is considering a project which requires the purchase of $164,000 of fixed assets. The net present value of the project is $4,500. Equity shares will be issued as the sole means of financing this project. The price-earnings ratio of the project equals that of the existing firm. What will the new market value per share be after the project is implemented given the following current information on the firm?

A. $20.68 B. $20.72 C. $20.80 D. $20.95 E. $21.10 Current market value per share = $457,600/22,000 = $20.80 Number of new shares needed = $164,000/$20.80 = 7,884.62 shares New market value per share = ($457,600 + $164,000 + $4,500)/(22,000 + 7,884.62) = $20.95

AACSB: Analytic Bloom's: Application Difficulty: Intermediate Learning Objective: 15-3 Section: 15.9 Topic: Market value

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Chapter 15 - Raising Capital

76. Wagner Trucking is considering investing in a new project that will cost $13 million and increase net income by 6.5 percent. This project will be completely funded by issuing new equity shares. Currently, the firm has 1.25 million shares of stock outstanding with a market price of $42 per share. The current earnings per share are $1.82. What will the earnings per share be if the project is implemented? A. $1.39 B. $1.45 C. $1.55 D. $1.62 E. $1.69 New earnings per share = ($1.82 × 1.25m × 1.065)/[1.25m + ($13m/$42)] = $1.55

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.9 Topic: Earnings per share

77. You own 15 percent or 13,500 shares of Printers, Etc. These shares have a total market value of $426,600. By what percentage will the total value of your investment in this firm change if the company sells an additional 10,000 shares of stock at $30 a share and you do not buy any? A. -1.37 percent B. -1.21 percent C. -0.51 percent D. 1.03 percent E. 1.29 percent Current number of shares outstanding = 13,500/0.15 = 90,000 Price per share = $426,600/13,500 = $31.60 New market value per share = [(90,000 × $31.60) + (10,000 × $30)]/(90,000 + 10,000) = $31.44 Percent change = ($31.44 - $31.60)/$31.60 = -0.51 percent

AACSB: Analytic Bloom's: Application Difficulty: Intermediate Learning Objective: 15-3 Section: 15.9 Topic: Dilution

15-70

Chapter 15 - Raising Capital

78. Kurt currently owns 3.4 percent of Northeastern Transportation. The company has a total of 438,000 shares outstanding with a current market price of $26.20 a share. At present, the firm is offering an additional 25,000 shares at a price of $25 a share. Kurt decides not to participate in this offering. What will his ownership position be after the offering is completed? A. 3.06 percent B. 3.22 percent C. 3.27 percent D. 3.40 percent E. 3.51 percent Number of shares owned = 0.034 × 438,000 = 14,892 New ownership position = 14,892/(438,000 + 25,000) = 3.22 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic Learning Objective: 15-3 Section: 15.9 Topic: Dilution

Essay Questions

79. It can be argued that the decision to accept venture capital is one of the most critical decisions an entrepreneur must make. Explain why. The potential rewards from venture capital can be substantial but the costs to the entrepreneur are equally substantial. The primary advantage of venture capital funding is the access to capital when funds are unavailable from other sources. In addition, a venture capitalist provides industry experience, expertise, and valuable business contacts. However, nothing is free. In exchange for this funding, entrepreneurs have to sacrifice a large percentage of their ownership rights to the venture capitalist. If venture capital is not accepted, the firm may fail for lacking of funding. If venture capital is accepted, there's no guarantee of success; only a guarantee that the entrepreneur will own less of the firm.

AACSB: Reflective thinking Bloom's: Analysis Difficulty: Basic Learning Objective: 15-1 Section: 15.1 Topic: Venture capital

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Chapter 15 - Raising Capital

80. Explain both a rights offering and the basic characteristics of a right. A rights offering is an issue of common stock that is initially offered for sale to a firm's current shareholders. Shareholders generally receive one right for each share of stock owned. Each right grants its holder the ability to purchase a stated amount of new shares at a stated price during a stated period of time. If the recipient of a right decides not to participate in the rights offering, then he or she can sell that right to another investor who does want to participate. Selling stock via a rights offering is generally a cheaper method of issuing securities than a general cash offer.

AACSB: Reflective thinking Bloom's: Comprehension Difficulty: Basic Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

81. Explain why there is a tendency for IPOs to be underpriced. Several reasons have been given for underpricing an IPO. These include: 1. determining the correct offering price is extremely difficult, 2. underpricing helps ensure the success of the security offering, 3. underpricing is just an indirect cost of a securities issue, 4. underpricing rewards IPO investors for purchasing risky securities, 5. underpricing addresses the issue of the "winner's curse", and 6. underpricing rewards institutional investors for the information they provide to underwriters regarding the potential interest in and value of a security issue.

AACSB: Reflective thinking Bloom's: Comprehension Difficulty: Basic Learning Objective: 15-3 Section: 15.5 Topic: IPO underpricing

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Chapter 15 - Raising Capital

82. Firms encounter several costs when issuing new securities. Identify and describe at least four of these costs. Students should provide a partial discussion of the information found at the beginning of SECTION 15.7 where 6 different types of costs are identified and defined. These are:

AACSB: Reflective thinking Bloom's: Knowledge Difficulty: Basic Learning Objective: 15-3 Section: 15.7 Topic: Underwriting costs

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Chapter 15 - Raising Capital

83. Steve is the founder of Jefferson & Westover. Recently, the firm decided to issue an IPO with Steve retaining 30 percent ownership of the firm. The IPO agreement contained both a Green Shoe provision and a 6-month lockup agreement. Steve's cost basis per share is $15. The offering price for the IPO was $16. On the first day of trading, the market price per share rose to $28.20 and closed for the day at $25.60. Now, six months after the IPO release, the stock is valued at $15.40 a share. Explain who benefited the most during the lockup period, an outside investor or Steve, and why. As a company insider, the lockup agreement has prevented Steve from selling any of his shares and benefiting from the substantial price increase to $28.20 a share. Thus, Steve still owns all of his shares and has a current profit of $0.40 a share. Meanwhile, Outside Investor A could have purchased shares for $16 and sold them at $28.20 each. Outside Investor B, could have bought the shares at $28.20 and suffered a loss since the shares have declined in value since that point. Thus, who is better off depends upon the price at which the outside investor purchased shares.

AACSB: Reflective thinking Bloom's: Analysis Difficulty: Intermediate Learning Objective: 15-3 Section: 15.4 Topic: Lockup agreement

Multiple Choice Questions

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Chapter 15 - Raising Capital

84. The Timken Company has announced a rights offer to raise $25 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a nonrefundable reviewing fee of $2,500 per page. The stock currently sells for $48 per share, and there are 2.6 million shares outstanding. The subscription price is set at $43 per share. What is the ex-rights price per share? A. $45.58 B. $47.09 C. $48.15 D. $48.80 E. $49.42 Number of new shares = $25m/$43 = 581,395.35 Number of rights needed to buy one share = 2.6m/581,395.35 = 4.472 Ex-rights price per share = [$43 + 4.472($48)]/[1 + 4.472] = $47.09

AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 15-2 Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

15-75

Chapter 15 - Raising Capital

85. The Warm Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share price will fall from $100 to $95 ($100 is the rights-on-price; $95 is the ex-rights price, also known as the whenissued price). The company is seeking $18 million in additional funds with a per-share subscription price of $50. How many shares of stock are outstanding, before the offering? (Assume that the increment to the market value of the equity equals the gross proceeds of the offering.) A. 324,000 B. 360,000 C. 1,800,000 D. 3,240,000 E. 3,600,000 PEx = $95 = ($50 + $100N)/(N + 1); N = 9 Number of new shares = $18m/$50 = 360,000 shares Number of old shares = 9 × 360,000 = 3,240,000 shares

AACSB: Analytic Bloom's: Analysis Difficulty: Basic EOC #: 15-3 Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

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Chapter 15 - Raising Capital

86. The Woods Co. and the Mickelson Co. have both announced IPOs at $43 per share. One of these is undervalued by $20, and the over is overvalued by $14, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. What is the amount of the difference between your expected profit and the amount of profit you could earn if you could get 1,000 shares of Woods and 1,000 shares of Mickelson? A. -$10,000 B. -$6,000 C. -$4,000 D. $4,000 E. $6,000 Expected profit = 500($20) + 1,000(-$14) = -$4,000 Profit if 1,000 shares of each = 1,000($20) + 1,000(-$14) = $6,000 Difference = -$4,000 - $6,000 = -$10,000

AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 15-4 Learning Objective: 15-3 Section: 15.5 Topic: IPO underpricing

87. Flagler, Inc. needs to raise $30 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. The offer price is $30 per share and the company's underwriters charge a 10 percent spread. How many shares need to be sold? A. 1,111,111 shares B. 1,250,000 shares C. 1,666,667 shares D. 2,500,000 shares E. 3,333,333 shares Required sales proceeds: $30m = x (1 - 0.10); x = $33,333,333 Number of shares needed = $33,333,333/$30 = 1,111,111

AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 15-5 Learning Objective: 15-3 Section: 15.7 Topic: Flotation costs

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Chapter 15 - Raising Capital

88. The Educated Horses Corporation needs to raise $20 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. Suppose the offer price is $40 per share and the company's underwriters charge an 8 percent spread. The SEC filing fee and associated administrative expenses of the offering are $660,000. How many shares need to be sold? A. 448,907 B. 461,222 C. 511,111 D. 529,937 E. 561,413 Required sales proceeds: $20m + $0.66m = x (1 - 0.08); x = $22,456,522 Number of shares needed = $22,456,522/$40 = 561,413

AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 15-6 Learning Objective: 15-3 Section: 15.7 Topic: Flotation costs

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Chapter 15 - Raising Capital

89. The Huff Co. has just gone public. Under a firm commitment agreement, Huff received $21.50 for each of the 6 million shares sold. The initial offering price was $23.65 per share, and the stock rose to $30.51 per share in the first few minutes of trading. Huff paid $1,260,000 in direct legal and other costs, and $390,000 in indirect costs. The flotation costs were what percentage of the funds raised? A. 38.56 percent B. 40.32 percent C. 41.68 percent D. 43.75 percent E. 44.09 percent Net amount raised = 6m ($21.50) - $1,260,000 - $390,000 = $127,350,000 Total direct costs = $1,260,000 + ($23.65 - $21.50) (6m) = $14,160,000 Total indirect costs = $390,000 = ($30.51 - $23.65) (6m) = $41,550,000 Total costs = $14,160,000 + $41,550,000 = $55,710,000 Flotation cost percentage = $55,710,000/$127,350,000 = 43.75 percent

AACSB: Analytic Bloom's: Application Difficulty: Basic EOC #: 15-7 Learning Objective: 15-3 Section: 15.7 Topic: Flotation costs

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Chapter 15 - Raising Capital

90. Mountain Homes wishes to expand its facilities. The company currently has 7 million shares outstanding and no debt. The stock sells for $55 per share, but the book value per share is $43. The firm's net income is currently $9.1 million. The new facility will cost $30 million, and it will increase net income by $309,000. Assume the firm issues new equity to fund this expansion while maintaining a constant price-earnings ratio. What will be the EPS be after the new equity issue? A. $1.25 B. $1.30 C. $1.35 D. $1.40 E. $1.45 Number of shares after the offering = 7m + ($30m/$55) = 7,545,454.545455 New EPS = ($9.1m + $309,000)/7,545,454.545455 = $1.25

AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate EOC #: 15-9 Learning Objective: 15-3 Section: 15.9 Topic: Dilution

15-80

Chapter 15 - Raising Capital

91. The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:

MHMM is considering an investment that has the same P/E ratio as the firm. The cost of the investment is $798,270, and it will be financed with a new equity issue. What would the ROE on the investment have to be if we wanted the price after the offering to be $110 per share? Assume the PE ratio remains constant. A. 18.28 percent B. 21.41 percent C. 27.63 percent D. 37.27 percent E. 40.03 percent Current ROE = $451,000/($4,631,000 - $2,315,500) = 0.19477435 New net income = 0.19477435 ($4,631,000 - $2,315,500 + $798,270) = $606,483 Number of new shares = $798,270/$110 = 7,257 New EPS = $606,483/(11,000 + 7,257) =$33.22 Current P/E = $110/($451,000/11,000) = 2.6829 Necessary EPS = $110 = 2.6829(Necessary EPS); Necessary EPS = $41 Necessary net income = $41 (7,257) = $297,537 New ROE = $297,537/$798,270 = 37.27 percent

AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate EOC #: 15-11 Learning Objective: 15-3 Section: 15.9 Topic: Dilution

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Chapter 15 - Raising Capital

92. Precise Machining is considering a rights offer. The company has determined that the exrights price would be $46. The current price is $53 per share, and there are 7 million shares outstanding. The rights offer would raise a total of $70 million. What is the subscription price? A. $26.48 B. $27.06 C. $27.50 D. $28.18 E. $29.10 Number of new shares = $70m/PS NEx = 7m/($70m/PS) = 0.1PS PX = $46 = [0.1PS($53) + PS]/(0.1PS + 1); PS = $27.06

AACSB: Analytic Bloom's: Application Difficulty: Intermediate EOC #: 15-12 Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

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Chapter 15 - Raising Capital

93. Atlas Corp. wants to raise $4 million via a rights offering. The company currently has 450,000 shares of common stock outstanding that sell for $40 per share. Its underwriter has set a subscription price of $26 per share and will charge the company a 7 percent spread. Assume that you currently own 7,200 shares of stock in the company and decide not to participate in the rights offering. How much can you get for selling all of your rights? A. $24,911.21 B. $25,362.84 C. $25,792.19 D. $26,414.14 E. $27,094.95 Net proceeds to firm = $26 (1 - 0.07) = $24.18 New shares offered = $4m/$24.18 = 165,425.97 Number of rights needed per share = 450,000/165,425.97 = 2.72025 PEx = [$26 + 2.72025($40)]/(1 + 2.72025) = $36.24 Right value = $40 - $36.24 = $3.76 Sale proceeds = $3.76 (7,200) = $27,094.95

AACSB: Analytic Bloom's: Analysis Difficulty: Intermediate EOC #: 15-14 Learning Objective: 15-4 Section: 15.8 Topic: Rights offer

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