Question

A company issues a $200 million IPO. The offer price is $5 per share. The underwriter’s spread is 8%. The underwriter has agreed to a stand-by arrangement. For issuing the IPO, the company will pay some admin costs. The admin costs include a legal fee of $50,000, an accountant fee of $30,000 and other admin costs amounting to $170,000. The company’s share price increases by 10% at the end of the first day of trading. However, the offer has not been as successful as expected, and only 95% of the shares have been sold.

1. Determine the company’s total cost of issuing the securities.
2. Determine proceeds available to the underwriter and to the issuer.           
3. How will the proceeds available to underwriter change for a best-effort arrangement?

If the arrangement was best-effort instead of stand-by, who would have borne more risk? The underwriter or the issuer? Why?

Answer 1

1) companies total cost of issuing securities

=$50000+$30000+$170000+$30m=$30250000

2) proceeds available to the underwriter= 200*5=$1000 *8% =$80m

1000m*5%=$50m

Therefore met proceeds for underwriter =80-50= $30m

Procceds for issuer 200m×5 =1000m - cost of issue

Ie,$1000m-$30.25m=$969.75m

3)BEST EFFORT UNDERWRITING is agreement between an underwriter and an issuer in which the underwriter agrees to place as much of an offering with investors as possible, but is not responsible for any portion of the offering it fails to sell.

In this case if it was best effort under writing , then

Proceeds to underwriter would be 1000m*8%=$80m ,since he don't need to buy $50m worth stocks which was not sold

I'm case if this was best effort UNDERWRITING then issuee will bear more risk since the unsold security will not be bought by underwriters ,which may result in undersubsription and lead to the failure of IPO

Thank tou