Question

An investment bank agrees to underwrite an issue of 20,000,000 shares for Murray Construction
on a firm commitment basis. The investment bank pays $15.50 per share to Murray construction
and it sells those shares to public for $16.35.
 What is profit of Investment Bank?
 How much money does Murray Construction receive if share sells for $14.75?
 What will be profit of Investment bank if they agree on best effort basis and charge
$0.375 per share, assuming they sold 18,400,000 shares?

Answer 1

Sol:

Issue size = 20,000,000

Investment bank pays for the issue = $15.50 per share

Investment bank sells shares to the public = $16.35 per share

i) Profit for investment bank = 20,000,000 x ($16.35 - $15.50)

Profit for investment bank = 20,000,000 x 0.85 = $17,000,000

ii) To determine money Murray Construction receive if share sells for $14.75:

The money received by Murray Construction will be = 20,000,000 x $15.50 = $310,000,000

The investment bank already commited to pay $15.50 per share to Murray Construction, therefore Murray Construction will receive proceeds as per $15.50. If share sells for $14.75 in the market based on demand and supply basis then its a loss for investment bank:

Investment bank Loss = ($14.75 - $15.50) x 20,000,000 = -0.75 x 20,000,000 = -$15,000,000

iii) To determine profit of Investment bank if they agree on best effort basis and charge $0.375 per share, assuming they sold 18,400,000 shares:

Profit of Investment bank = 18,400,000 x $0.375 = $6,900,000