Question

An investment bank agrees to underwrite an issue of 18 million shares of stock for Looney Landscaping Corp. The investment bank underwrites the stock on a firm commitment basis and agrees to pay $15.00 per share to Looney Landscaping Corp. for the 18 million shares of stock. The investment bank then sells those shares to the public for $16.25 per share. If the investment bank can sell the shares for only $13.75, how much money does Looney Landscaping Corp. receive?

Answer 1

Solution:

As per the information given in the question

The investment bank underwrites the stock of Looney Landscaping Corp. on a firm commitment basis and agrees to pay $15.00 per share for the 18 million shares of stock.

Thus amount payable be the Investment bank to Looney Landscaping Corp. on a firm commitment basis

= Number of shares of stock * Firm commitment price per share

= 18 million * $ 15.00

= $ 270 million

= $ 270,000,000

Thus the amount that the Investment bank will pay to Looney Landscaping corp. as per firm commitment basis = $ 270,000,000

If the Investment bank sells the share to the public for $ 16.25 per share :

If the Investment bank sells the share to the public for $ 16.25 per share it makes a profit of

= ( Price per share at which stock is sold to the public - Firm commitment price per share ) * Number of shares of stock

= ( $ 16.25 - $ 15.00 ) * 18,000,000

= $ 1.25 * 18,000,000

= $ 22,500,000

If the market price of the share is $ 16.25, the amount that that the Investment bank will pay to Looney Landscaping corp. as per firm commitment basis shall remain unchanged.

The underwriting agreement provided Looney Landscaping corp. with a Firm commitment price of $ 15.00 per share irrespective of the market price.

Thus the amount that Looney Landscaping Corp. will receive shall be = $ 270,000,000

If the Investment bank sells the share to the public for $ 13.75 per share :

If the Investment bank sells the share to the public for $ 13.75 per share it makes a loss of

= ( Price per share at which stock is sold to the public - Firm commitment price per share ) * Number of shares of stock

= ( $ 13.75 - $ 15.00 ) * 18,000,000

= - $ 1.25 * 18,000,000

= - $ 22,500,000

If the market price of the share is $ 13.75, the amount that that the Investment bank will pay to Looney Landscaping corp. as per firm commitment basis shall remain unchanged.

The underwriting agreement provided Looney Landscaping corp. with a Firm commitment price of $ 15.00 per share irrespective of the market price.

Thus the amount that Looney Landscaping Corp. will receive shall be = $ 270,000,000

Thus the money that Looney Landscaping Corp. receives is = $ 270,000,000