Question

An investment bank agrees to underwrite an issue of 15 million shares of stock for Looney Landscaping Corp.

a. The investment bank underwrites the stock on a firm commitment basis, and agrees to pay $12.50 per share to Looney Landscaping Corp. for the 15 million shares of stock. The investment bank then sells those shares to the public for $13.25 per share. How much money does Looney Landscaping Corp. receive? What is the profit to the investment bank? If the investment bank can sell the shares for only $11.95, how much money does Looney Landscaping Corp. receive? What is the profit to the investment bank?

b. Suppose, instead, that the investment bank agrees to underwrite the 15 million shares on a best efforts basis. The investment bank is able to sell 13.6 million shares for $12.50 per share, and it charges Looney Landscaping Corp. $0.275 per share sold. How much money does Looney Landscaping Corp. receive? What is the profit to the investment bank? If the investment bank can sell the shares for only $11.95, how much money does Looney Landscaping Corp. receive? What is the profit to the investment bank?

(For all requirements, enter your answers in dollars, not in millions. Negative amounts should be indicated by a minus sign.)

Answer 1

a. If the investment bank sells the stock for $13.25 per share:-

Looney Landscaping Corp. receives$12.50 x 15,000,000 shares = $187,500,000.

The profit to the investment bank is ($13.25 -$12.50) x 15,000,000 shares = $11,250,000.

The stock price of Looney LandscapingCorp. is $13.25 since that is what the public agrees to pay,from the perspective of LooneyLandscapthe $11.25 million represents the commission that it must pay to issue thestock.

If the investment bank sells the stock for $11.95 per share,

Looney Landscaping Corp. receives $12.50 x 15,000,000 shares = $187,500,000.

The profit to the investment bank is($11.95 - $12.50) x 15,000,000 shares = -$8,250,000.

The stock price of Looney LandscapingCorp. is $11.95 since that is what the public agrees to pay, from the perspective of theinvestment bank, the -$8.25 million represents a loss for the firm commitment it made to LooneyLandscaping Corp. to issue the stock.

b. If the investment bank sells the stock for $12.50 per share,

Looney Landscaping Corp. receives($12.50 - $0.275) x 13,600,000 shares = $166,260,000,

the investment bank’s profit is $0.275 x13,600,000 shares = $3,740,000, and the stock price is $12.50 per share.

If the investment bank sells the stock for $11.95 per share,

Looney Landscaping Corp. receives($11.95 - $0.275) x 13,600,000 shares = $158,780,000,

the investment bank’s profit is still$0.275 x 13,600,000 shares = $3,740,000, and the stock price is $11.95 per share.