Question

Q6(b)
A company issues a $280 million IPO. The offer price is set to $10 per share. The underwriter’s spread is 8%.
The underwriter has agreed to a best-effort 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 $35,000 and other admin costs amounting to $85,000. The company’s share price increases by 5% at the end of the first day of trading.
i.   Determine the company’s total cost of issuing the securities..
ii. Determine proceeds available to the underwriter and to the issuer if 92% of the shares are sold.	(1 mark)
iii. Who bears more risk under the current arrangement? The underwriter or the issuer? Why?	(1 mark)
iv. How will the proceeds available to the issuer and to the underwriter change for a stand-by arrangement?

Answer 1

1. Total Cost = $50000 + $ 35000 + $85000 + (8% * $280000000)

Total Cost = $50000 + $ 35000 + $85000 + $22400000

Total Cost = $22,570,000

2.Proceed to issuer = ($280000000 * 92%) - [$50000 + $ 35000 + $85000 + (8% * $280000000*92%)]

Proceed to issuer = $257600000 - [$170000 + $20608000]

Proceed to issuer = $257600000 - $20778000

Proceed to issuer = $236,822,000

Proceed to underwriter = 8% * $280000000*92%

Proceed to underwriter = $20608000

3.Under the current arrangement assuming its not a standby arrangement, issuer bears the risk of not getting enough subscription for the IPO and not the underwriter.underwriter has risk that it will not earn sufficient income but issuer having the risk of loss.

4.Standby arrangement : It is an arrangement where underwriter agrees to buy the securities not subscribed by public.In our question 92% securities are subscribed by public so underwriter will buy the rest 8% secorities if entered into standby arrangement.

Proceed to issuer = ($280000000 * 100%) - [$50000 + $ 35000 + $85000 + (8% * $280000000*100%)]

Proceed to issuer = $280000000 - [$170000 + $22400000]

Proceed to issuer = $280000000 - $22570000

Proceed to issuer = $257430000

Proceed to underwriter = [8% * $280000000*100%] - [(100-92) * $280000000]

Proceed to underwriter = $22400000 - $22400000

Proceed to underwriter = 0