Question

-What are costs associated of going public (both direct and indirect)? Why are costs higher for IPO than for SEO? Why are the cost of raising equity capital higher than that of debt? Who bears these costs of raising capital? Explain

-Which market imperfections lead a cost of outside capital? How do the availability and cost of outside capital affect payout (dividend) policy?

-Explain the logic of the residual payout (dividend) model and the steps a firm would take to implement it.

-Many companies that go public with an IPO don’t actually need additional cash (AFN = 0). Why might such a firm decide to go public? Provide 4 key reasons according to survey data.

Answer 1

costs associated of going public (both direct and indirect)

The costs of going public can be separated into four main categories; Pre-IPO direct costs, pre-IPO indirect costs, post-IPO one-time costs and post-IPO recurring costs. The specific costs in each of these categories are listed in the following table and are discussed in detail throughout the article.

1 PRO IPO DIRECT COST

UNDERWRITER , LEGAL , AUDITOR , IPO CONSULTANT , LISTING FEES

2 PRO IPO INDIRECT COST

RESTRUCTURING COST , COST TO MAKE FINANCIAL , AUDIT COMMITTEE ARTICLE OF INCORPORATION ETC

3.POST IPO ONE TIME COST

NEW FINANCIAL REPORTING SYSTEM , IMPLEMENTATION OF NEW CONTROL , NEW BOARD OF DIRECTOR

costs higher for IPO than for SEO

Seasoned issues, also known as secondary offerings or subsequent offerings, involve the issuance of additional shares of a publicly traded company to the public. Given that the company's shares already trade in the secondary market, the underwriters handling the seasoned or secondary offering price the shares at the prevailing stock market price on the day of the offering.

When a privately-owned company decides to raise capital by offering shares of stock or debt securities to the public for the first time, it conducts an initial public offering, at which point it becomes a publicly traded company.

If and when a company decides to sell shares of its stock to the public to raise money for operations or other uses, it engages the services of one or more investment banks to act as the underwriters responsible for managing the underwriting process of the IPO.

The underwriters help the company organize and file information that is required by regulators; they also create a prospectus disclosing all relevant information about the company (covering investment basics regarding finances and operations) and making it available to the public

the cost of raising equity capital higher than that of debt

Creditors have to be paid back before equity shareholders, since equity holders are always considered to be the last stakeholders to be accounted. Because of this high risk, cost of equity should be higher than cost of debt.

Debt is cheaper, but the company must pay it back. Equity does not need to be repaid, but it generally costs more than debt capital due to the tax advantages of interest payments. Since the cost of equity is higher than debt, it generally provides a higher rate of return.

the logic of the residual payout (dividend) model

The dividend policy decision involves the choice between distributing the profits belonging to the shareholders and their retention by the firm. A major decision area of Financial management is the dividend policy decision in the sense that the firm has to choose between distributing the profits to the shareholders and ploughing them back into the business. The selection would be influenced by the effect on the objective of Financial Management of maximising shareholder’s wealth.

The firm should pay dividend if the payment will lead to the maximisation of the wealth of the owners and if not then the firm should retain profits to finance investment programmes. The relationship between dividends and value of the firm should, therefore, be the decision criterion. There are conflicting opinions regarding the impact of dividends on the valuation of a firm.

a firm decide to go public

• Increase cash and liquidity. The promise of increased liquid assets is one of the most significant advantages of going public.
• Better credibility and brand strength. ...
• Increase market value. ...
• Attract personnel. ...
• Collateral acquisition