A new enterprise after struggling for a few years has finally become a viable candidate for...

A new enterprise after struggling for a few years has finally become a viable candidate for an IPO. The investment bankers with the aid of the management forecast net earnings after taxes (net income) of $30,000, $40,000, 50,000, and $60,000 for each of the next four years. Depreciation is estimated to be $3,000, $3,500, $4,000, and $4,500 in each of the next four years. The tax rate is 35%. The firms in the industry were compiled and those closest to the firm were isolated and their average beta of 1.5 was considered as the best estimate for the firm. The risk-free rate is 4% and the return on market averages 12%. The bankers after considerable thought decided on an annual rate of 5% beyond year 4. The bankers one time net cost inclusive of all the fees and concessions is estimated to be around 5% of the value of the firm.

How many shares will be issued if the bankers set the price at $10 per share?

Expert Solution

Average beta = 1.5
Risk free rate = 4%
Market return = 12%

Return on equity as per CAPM model
= Risk free return + Beta * (Market return - risk free return)
= 4% + 1.5 (12%-4%)
=16%

Year	Cash flows	Tax savings on depreciation	Total	PVF 16%	Disc CF
1	$ 30,000.00	$ 1,050.00	$ 31,050.00	0.8621	$ 26,767.24
2	$ 40,000.00	$ 1,225.00	$ 41,225.00	0.7432	$ 30,636.89
3	$ 50,000.00	$ 1,400.00	$ 51,400.00	0.6407	$ 32,929.80
4	$ 60,000.00	$ 1,575.00	$ 61,575.00	0.5523	$ 34,007.32

					$ 124,341.26
	Value of the firm = $ 124341.26
	Add: Bank charges = 5% on the above = $ 124341.26*5% = $ 6217.06
	Total amount to be raised = $ 130560 (Rounding off) [$ 130558.32]

	Share price = $ 10
	No of sahres to be issued = $ 130560/ $10 = 13056

jeff jeffy answered 2 years ago

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