Question

An investment banker agrees to underwrite an issue of 10 million shares of stock for XYZ Corp. on a firm commitment basis. The investment banker pays $25.50 per share to XYZ Corp. for the 20 million shares of stock. It then sells those shares to the public for $26.35 per share.

a) How much money does XYZ Corp. receive?

b) What is the profit to the investment banker?

c) if the investment bank can sell the shares for only $24.75 instead of $26.35, how much money does XYZ Corp. receive?

d)What is the profit to the investment banker?

Answer 1

Firm Underwritingrefers to a definite commitment by the underwriter or underwriters to take up a specified number of shares or debentures of a company irrespective of the number of shares or debentures subscribed for by the public. In such a case, the underwriters are committed to take up the agreed number of shares or debentures in addition to unsubscribed shares or debentures, if any. Even if the issue is over-subscribed, the underwriters are liable to take up the agreed number of shares of debentures.

a) XYZ Corp. Receives = 20 Million Shares × 25.50

= 510 Million

b) Profit to Investment Banker =( 26.35-25.50)× 20 Million Shares

=17 Million

c) If the shares are sold only for $24.75 then XYZ Corp will recieve the below amount

10 Million Shares underwritten × $25.50+ 10 Million Shares * $24.75

=502.5 Million

d) Profit to the investment banker

=(26.35-25.50)× 10 Million Shares

=$8.5 Million