Question

Fishwick Enterprises has 207,500 shares outstanding, half of which are owned by Jennifer Fishwick and half by her cousin. The two cousins have decided to sell 105,000 shares in an IPO. Half of these shares would be issued by the company to raise new cash, and half would be shares that are currently held by Jennifer Fishwick. Suppose that the shares are sold at an issue price of $50 but rise to $80 by the end of the first day’s trading. Suppose also that investors would have been prepared to buy the issue at $80.

a. What percentage of the company will Jennifer own after the issue? (Round your answer to the nearest whole percentage.)

b. What will her holding be worth at the end of the first day’s trading?

c. Suppose the issue had been priced at $80. How many shares would the company have needed to sell to raise the same gross proceeds from the IPO?

d. What in this case would be Jennifer’s wealth (cash plus the value of her remaining holding)? (Enter your answer in millions rounded to 1 decimal place.)

e. What is the cost of underpricing to Jennifer in dollars? (Enter your answer in millions rounded to 1 decimal place.)

Answer 1

Answer:

a. Jennifer will have 52500 (105000/2) shares left after contributing 52500 to the 105,000 issue. The company will have a total of 260,000 (207500+52500) shares outstanding after issuing 52500 shares.  Therefore, Jennifer’s stake in the enterprise will be: 52500/260000 = 0.20 or 20.19%

b.                  The stock price will be $80 by end of day and Jennifer owns 52500 shares, so her stake is worth: 52500 × $80 = 4,200,000.

c. The amount raised was: $50 × 105000 = $5,250,000. Therefore, at $80 per shares the issue would have been: $5250000/ $80 = 65625 shares.

d.                  Jennifer owns 52500 shares worth $80 for a total value of $4.2 million.  In addition, she sold a 52500 share stake for the issue price of $50, so she has cash of $2.625 million (assuming no direct issue costs). Therefore, her total wealth would be $6.825 million.

e.                   Jennifer would have received $8.4 million (105000*$80) in value if shares were issued at $80 per share.  She ultimately received $6.825 million, so her costs was $1.575 million.