Question

S&S Air Goes Public Mark Sexton and Todd Story have been discussing the future of S&S Air. The company has been experiencing fast growth, and the two see only clear skies in the company’s future. However, the fast growth can no longer be funded by internal sources, so Mark and Todd have decided the time is right to take the company public. To this end, they have entered into discussions with the investment bank of Crowe & Mallard. The company has a working relationship with Renata Harper, the underwriter who assisted with the company’s previous bond offering. Crowe & Mallard have assisted numerous small companies in the IPO process, so Mark and Todd feel confident with this choice. Renata begins by telling Mark and Todd about the process. Although Crowe & Mallard charged an underwriter fee of 4 percent on the bond offering, the underwriter fee is 7 percent on all initial stock offerings of the size of S&S Air’s offering. Renata tells Mark and Todd that the company can expect to pay about $1,800,000 in legal fees and expenses, $12,000 in SEC registration fees, and $15,000 in other filing fees. Additionally, to be listed on the NASDAQ, the company must pay $100,000. There are also transfer agent fees of $6,500 and engraving expenses of $520,000. The company should also expect to pay $110,000 for other expenses associated with the IPO. Finally, Renata tells Mark and Todd that to file with the SEC, the company must provide three years’ audited financial statements. She is unsure about the costs of the audit. Mark tells Renata that the company provides audited financial statements as part of the bond covenant, and the company pays $300,000 per year for the outside auditor.

This is the last question on the case study below!!!

d. 5 years after IPO, S&S Air is planning to raise fresh equity capital by selling a large new issue of common stock. S&S Air is currently a publicly traded corporation, and it is trying to choose between an underwritten cash offer and a rights offering (not underwritten) to current shareholders. S&S Air management is interested in minimizing the selling costs and has asked you for advice on the choice of issue methods. What is your recommendation and why?

Answer 1

The amount to be spent by company under both the options have been presented below:

Option 1: Underwritten cash offer
Particulars	Amount $
Underwriting fee	7%
Legal fees and expenses	1800000
SEC registration fees	12000
Other filing fees	15000
Other expenses related to IPO	110000
Transfer agent fees	6500
Engraving expenses	520000
NASDAQ listing fees	100000
Total	2563500

Option 2: Right shares
Particulars	Amount $
Legal fees and expenses	1800000
SEC registration fees	12000
Other filing fees	15000
Other expenses related to IPO	110000
Transfer agent fees	6500
Engraving expenses	520000
NASDAQ listing fees	100000
	2563500

From the above analysis, we can make out that in case of underwritten cash offer, the company will have to additionally pay 7% of initial public offering to the underwriters as compared to issue of right shares. However, since the company at present does not have much funds, opting for a rights issue is not recommendable as in case of right shares, there is no surety regarding the amount being received by the company. However in case of an underwritten issue, though the underwriting fees has to be paid, there is assurance of all shares of the company being subscribed by the underwriters.

Thus, going by the concept of marginal costing, additional benefits in case of of underwritten cash offer is more than the additional cost of 7% underwriting fees.

Hence underwritten cash offer is preferred over rights issue.