Chapter 15 Discussion Questions 15-1 In what way is an investment banker a risk taker? The investment banker is a risk taker(underwriter) in that the investment banking house agrees to buy the securities from the corporation and resell them to other security dealers and the public What is the purpose of market stabilization activities during the distribution Market stabilization activities are managed in an attempt to insure that the market price will not fall below a desired level during the distribution process Synd icate members committed to purchasing the stock at a given level could be in trouble if there is a rapid decline in the price of the stock 15-3 Discuss how an underwriting syndicate decreases risk for each underwriter and at the same time facilitates the distribution process By forming a syndicate of many underwriters rather than just one, the overall risk is diffused and the capabilities for widespread distribution are enhanced. A syndicate may comprise as few as two or as many as 50 investment banking he louses 15-4 Discuss the reason for the differences between underwriting spreads for stock and bonds Common stocks often carry a larger underwriting spread than bonds because the market reaction to stocks is more uncertain 15-5 Explain how the price of a new security issue is determined The price is determined by the firms industry, its financial characteristics, and the firms anticipated earnings and divided pay ing capability. Based on appropriate valuation techniques, a price will be tentatively assigned and will be compared to that enjoyed by similar firms in a given industry. If the industry's price-earnings ratio is 12, the firm should not stray too far from the norm. Anticipated public demand will also be a major factor in pricing a new CopyrightC 2005 by The McGray-Hill Companies, Inc. S-524
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-524 Chapter 15 Discussion Questions 15-1. In what way is an investment banker a risk taker? The investment banker is a risk taker (underwriter) in that the investment banking house agrees to buy the securities from the corporation and resell them to other security dealers and the public. 15-2. What is the purpose of market stabilization activities during the distribution process? Market stabilization activities are managed in an attempt to insure that the market price will not fall below a desired level during the distribution process. Syndicate members committed to purchasing the stock at a given level could be in trouble if there is a rapid decline in the price of the stock. 15-3. Discuss how an underwriting syndicate decreases risk for each underwriter and at the same time facilitates the distribution process. By forming a syndicate of many underwriters rather than just one, the overall risk is diffused and the capabilities for widespread distribution are enhanced. A syndicate may comprise as few as two or as many as 50 investment banking houses. 15-4. Discuss the reason for the differences between underwriting spreads for stocks and bonds. Common stocks often carry a larger underwriting spread than bonds because the market reaction to stocks is more uncertain. 15-5. Explain how the price of a new security issue is determined. The price is determined by the firm's industry, its financial characteristics, and the firm's anticipated earnings and divided-paying capability. Based on appropriate valuation techniques, a price will be tentatively assigned and will be compared to that enjoyed by similar firms in a given industry. If the industry's price-earnings ratio is 12, the firm should not stray too far from the norm. Anticipated public demand will also be a major factor in pricing a new issue
What is shelf registration? How does it differ from the trad itional requirements for security offerings? Shelf registration permits large companies to file one comprehensive registration statement(under SEC Rule 415). This statement outlines the firms plans for future long-term financing. Then, when market conditions appear to be appropriate, the firm can issue the securities without further SEC approval Shelf registration is different from the trad itional requirement that security issuers file a detailed registration statement for SEC review and approval each and eve ry time they plan a sale Comment on the market performance of companies going public, both immed iately after the offering has been made and some time later. Relate this to research that has been done in this area Due to underpricing by the investment banker, there is often a positive excess return immediately after the offering. With the passage of time, the efficiency of the market begins to become evident and long-term sustainable performance is very much dependent on the quality of the issue and market cond itions Discuss the benefits accruing to a company that is traded in the public securities mar The benefits of having a publicly traded security are a. Greater ability to raise capital b. Add itional prestige and visibility that can be helpful in bank negotiations, executive recruitment, and the marketing of products Increased liquid ity for existing stockholders d. Ease in estate planning for existing stockholders e. An increased capability to engage in the merger and acquisition process 15-9 What are the disad vantages to being public? The disad vantage of being public are a. All information must be made available to the public through SEC and state filings. This can be very expensive for a small company b. The president must be a public relations representative to the investment community c. Tremendous pressure is put on the firm for short-term performance d. Large downside movement in the stock can take place in a bear market e. The initial cost of going public can be very expensive for a small firm S-525 Copyright C2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-525 15-6. What is shelf registration? How does it differ from the traditional requirements for security offerings? Shelf registration permits large companies to file one comprehensive registration statement (under SEC Rule 415). This statement outlines the firm's plans for future long-term financing. Then, when market conditions appear to be appropriate, the firm can issue the securities without further SEC approval. Shelf registration is different from the traditional requirement that security issuers file a detailed registration statement for SEC review and approval each and every time they plan a sale. 15-7. Comment on the market performance of companies going public, both immediately after the offering has been made and some time later. Relate this to research that has been done in this area. Due to underpricing by the investment banker, there is often a positive excess return immediately after the offering. With the passage of time, the efficiency of the market begins to become evident and long-term sustainable performance is very much dependent on the quality of the issue and market conditions. 15-8. Discuss the benefits accruing to a company that is traded in the public securities markets. The benefits of having a publicly traded security are: a. Greater ability to raise capital. b. Additional prestige and visibility that can be helpful in bank negotiations, executive recruitment, and the marketing of products. c. Increased liquidity for existing stockholders. d. Ease in estate planning for existing stockholders. e. An increased capability to engage in the merger and acquisition process. 15-9. What are the disadvantages to being public? The disadvantage of being public are: a. All information must be made available to the public through SEC and state filings. This can be very expensive for a small company. b. The president must be a public relations representative to the investment community. c. Tremendous pressure is put on the firm for short-term performance. d. Large downside movement in the stock can take place in a bear market. e. The initial cost of going public can be very expensive for a small firm
If a company were looking for capital by way of a private placement, where ald it look for funds? Funds for private placement can be found through insurance companies, pension funds, mutual funds, and wealthy individuals 15-11 How does a leveraged buyout work? What does the debt structure of the firm normally look like after a leveraged buyout? What might be done to reduce the The use of a leveraged buy-out implies that either management or some other investor group borrows the needed cash to repurchase all the shares of the company. After the repurchase, the company exits with a lot of debt and heavy To reduce the debt load be sold off to ge cash. Also, returns from asset sales may be redeployed into higher return areas 15-12 How might a leveraged buyout eventually lead to high returns for companies? Companies may restructure their companies and once again take them public at a fit 15-13. What is privatization? In the international markets, investment bankers take companies private that were previously owned by the government CopyrightC 2005 by The McGray-Hill Companies, Inc. -526
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-526 15-10. If a company were looking for capital by way of a private placement, where would it look for funds? Funds for private placement can be found through insurance companies, pension funds, mutual funds, and wealthy individuals. 15-11. How does a leveraged buyout work? What does the debt structure of the firm normally look like after a leveraged buyout? What might be done to reduce the debt? The use of a leveraged buy-out implies that either management or some other investor group borrows the needed cash to repurchase all the shares of the company. After the repurchase, the company exits with a lot of debt and heavy interest expense. To reduce the debt load, assets may be sold off to generate cash. Also, returns from asset sales may be redeployed into higher return areas. 15-12. How might a leveraged buyout eventually lead to high returns for companies? Companies may restructure their companies and once again take them public at a large profit. 15-13. What is privatization? In the international markets, investment bankers take companies private that were previously owned by the government
Problems 15-1 Louisiana Timber Company currently has 5 million shares of stock outstanding d will report earnings of $9 million in the current year. The company is considering the issuance of 1 million additional shares that will net $40 per share to the corporation What is the immediate dilution potential for this new stock issue? b. Assume the louisiana Timber Company can earn 11 percent on the Should the new issue be undertaken based on earnings per share.? s results proceeds of the stock issue in time to include it in the current year Solutio Louisiana Timber Company a. Earnings per share before stock issue $9,000,000/500,000=$1.80 Earnings per share after stock issue $9000.000/6,000,000=$150 dilution $1.80 S 30 per share b Net income 9,000,000+.11($1,000,000x$40) $9,000,000+.11($40,000,000 $9,000,000+$4400,000 $13400,000 Earnings per share after additional income EPS=$13,400000/$6,000.000 =$223 Yes. the epS of $2.23 is higher than $1.80 S-527 oyrightC2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-527 Problems 15-1. Louisiana Timber Company currently has 5 million shares of stock outstanding and will report earnings of $9 million in the current year. The company is considering the issuance of 1 million additional shares that will net $40 per share to the corporation. a. What is the immediate dilution potential for this new stock issue? b. Assume the Louisiana Timber Company can earn 11 percent on the proceeds of the stock issue in time to include it in the current year's results. Should the new issue be undertaken based on earnings per share? Solution: Louisiana Timber Company a. Earnings per share before stock issue $9,000,000/5,000,000 = $1.80 Earnings per share after stock issue $9,000,000/6,000,000 = $1.50 dilution $1.80 1.50 $ .30 per share b. Net income = $9,000,000 + .11 ($1,000,000 x $40) = $9,000,000 + .11 ($40,000,000) = $9,000,000 + $4,400,000 = $13,400,000 Earnings per share after additional income EPS = $13,400,000/$6,000,000 = $2.23 Yes, the EPS of $2.23 is higher than $1.80
15-2 In problem 1, if the 1 million add itional shares can only be issued at $32 per share and the company can earn 5 percent on the proceeds, should the new issue be undertaken based on earnings per share? Solution Louisiana Timber Company( Continued) Net income=$9,000000+.05($1,000,000x$32) $9.000,000+.05($32,00000 =$9,000,000+$1600000 $10,600,000 Earnings per share after additional income EPS=$10,600,000/$6,000,000=$1.77 No, E. P.S. would decline by 3 cents from $1.80 to $1.77 CopyrightC 2005 by The McGray-Hill Companies, Inc. -528
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-528 15-2. In problem 1, if the 1 million additional shares can only be issued at $32 per share and the company can earn 5 percent on the proceeds, should the new issue be undertaken based on earnings per share? Solution: Louisiana Timber Company (Continued) Net income = $ 9,000,000 + .05 ($1,000,000 x $32) = $ 9,000,000 + .05 ($32,000,000) = $ 9,000,000 + $1,600,000 = $10,600,000 Earnings per share after additional income EPS = $10,600,000/$6,000,000 = $1.77 No, E.P.S. would decline by 3 cents from $1.80 to $1.77
Micromanagement, Inc has 8 million shares of stock outstanding and will eport earnings of $20 million in the current year. The company is considering the issuance of 2 million additional shares that will net $30 per share to the corDor a. What is the immediate dilution potential for this new stock issue? b. Assume that Micromanagement can earn 12.5 percent on the proceeds of the stock issue in time to include it in the current year,s results. Should the new issue be undertaken based on earnings per share? Solution: Micromanagement Inc. a. Earnings per share before stock issue $20,000,000/8,000,000=$2.50 Earnings per share after stock issue $20,00000/1000000=$2.00 dilution $2.50 2.00 S. 50 per share b. Net income=$20,000000.125(2,000,000X$30) =$20,000000.125(s60,000,000 $20000.000+$7,500,000 $27,500,000 Earnings per share after additional income EPS=$27,500,000/10,000,000 $2.75 Yes, the eps of $2. 75 is higher than $2. 50 S-529 Copyright C2005 by The McGra-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-529 15-3. Micromanagement, Inc. has 8 million shares of stock outstanding and will report earnings of $20 million in the current year. The company is considering the issuance of 2 million additional shares that will net $30 per share to the corporation. a. What is the immediate dilution potential for this new stock issue? b. Assume that Micromanagement can earn 12.5 percent on the proceeds of the stock issue in time to include it in the current year's results. Should the new issue be undertaken based on earnings per share? Solution: Micromanagement, Inc. a. Earnings per share before stock issue $20,000,000/8,000,000 = $2.50 Earnings per share after stock issue $20,000,000/10,000,000 = $2.00 dilution $2.50 2.00 $ .50 per share b. Net income = $20,000,000 + .125 (2,000,000 x $30) = $20,000,000 + .125 ($60,000,000) = $20,000,000 + $7,500,000 = $27,500,000 Earnings per share after additional income EPS = $27,500,000/10,000,000 = $2.75 Yes, the EPS of $2.75 is higher than $2.50
In problem 3, if the 2 million add itional shares can be issued at $27 per share and the company can earn 10.8 percent on the proceeds, should the new issue be undertaken based on earnings per share? Solution Micromanagement, Inc( Continued) Net income=$20,000,000+.108(2000,000X$27) $2000000+.108($54,000,000 =$20,0000+$5,832,000 $25,832,000 Earnings per share after additional income EPS=$25,832,000/10,00000 $258 Yes, the eps of $2.58 is still higher than $2.50 CopyrightC 2005 by The McGray-Hill Companies, Inc. -530
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-530 15-4. In problem 3, if the 2 million additional shares can be issued at $27 per share and the company can earn 10.8 percent on the proceeds, should the new issue be undertaken based on earnings per share? Solution: Micromanagement, Inc. (Continued) Net income = $20,000,000 + .108 (2,000,000 x $27) = $20,000,000 + .108 ($54,000,000) = $20,000,000 + $5,832,000 = $25,832,000 Earnings per share after additional income EPS = $25,832,000/10,000,000 = $2.58 Yes, the EPS of $2.58 is still higher than $2.50
Assume Safeguard Detective Company is thinking about three different size offerings for the issuance of ad ditional shares Size of offer Public price Net to Corporation a. S1.5 million $50 $46.10 b. $5.5 million $50 $4680 C. $20.0 million $4815 What is the percentage underwriting spread for each size offer? What principle does this demonstrate? Solution: Safeguard Detective Company a. Spread=$50-$46.10=$390(on$15 million) %underwriting spread =$3.90/$50=7.80% b Spread=$50-$46.80=$3.20(on $5.5 million) underwriting spread=$3.20/$50=6.40% c. Spread=$50-$4815=$1.85(on $20 million) underwriting spread=$1.85/$50=3.70% The principle demonstrated is the larger the offer size the lower the percentage spread CopyrightC2005 by The McGraw-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-531 15-5. Assume Safeguard Detective Company is thinking about three different size offerings for the issuance of additionalshares. Size of Offer Public Price Net to Corporation a. $1.5 million $50 $46.10 b. $5.5 million $50 $46.80 c. $20.0 million $50 $48.15 What is the percentage underwriting spread for each size offer? What principle does this demonstrate? Solution: Safeguard Detective Company a. Spread = $50 – $46.10 = $3.90 (on $1.5 million) % underwriting spread = $3.90/$50 = 7.80% b. Spread = $50 – $46.80 = $3.20 (on $5.5 million) % underwriting spread = $3.20/$50 = 6.40% c. Spread = $50 – $48.15 = $1.85 (on $20 million) % underwriting spread = $1.85/$50 = 3.70% The principle demonstrated is the larger the offer size, the lower the percentage spread
Blaine and Company is the managing investment banker for a major new Other synd icate members may buy the stock for $24.30. The price to the hare underwriting. The price of the stock to the investment banker is $24 per selected dealers group is $24.90, with a price to brokers of $25. 32. The price to the public is $25.60 a. If Blaine and Company sells its shares to the dealer group, what will be the percentage return? b. If Blaine and Company performs the dealer's function also and sells to brokers, what will be the percentage return? c. If Blaine and Company fully integrates its operation and sells directly to the oublic, what will be the percentage return? Solution: Blaine and company a.$24.90 Selected dealer group's price 24.00 Managing investing banker's price s 90 Differentia 90=3.75% Return $2400 b $25.32 Broker's price 24.00 Managing investment banker's price S 1.32 Differential $132 5.5% Return $24.00 c $25.60 Public price 24.00 Managing investment banker's price S 1.60 Differentia $160=667% Return $2400 CopyrightC 2005 by The McGray-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-532 15-6. Blaine and Company is the managing investment banker for a major new underwriting. The price of the stock to the investment banker is $24 per share. Other syndicate members may buy the stock for $24.30. The price to the selected dealers group is $24.90, with a price to brokers of $25.32. The price to the public is $25.60. a. If Blaine and Company sells its shares to the dealer group, what will be the percentage return? b. If Blaine and Company performs the dealer's function also and sells to brokers, what will be the percentage return? c. If Blaine and Company fully integrates its operation and sells directly to the public, what will be the percentage return? Solution: Blaine and Company a. $24.90 Selected dealer group's price 24.00 Managing investing banker's price $ .90 Differential $ .90 = 3.75% Return $24.00 b. $25.32 Broker’s price 24.00 Managing investment banker's price $ 1.32 Differential $ 1.32 = 5.5% Return $24.00 c. $25.60 Public price 24.00 Managing investment banker's price $ 1.60 Differential $ 1.60 = 6.67% Return $24.00
The Detroit Slugger Bat Company needs to raise $30 million. The investment banking firm of Kaline, Horton, greenberg will handle the transaction a. If stock is utilized, 1. 8 million shares will be sold to the public at $16.75 per share. The corporation will receive a net price of $16 per share. What is the percentage of underwriting spread per share? b. If bonds are utilized, slightly over 30,000 bonds will be sold to the public at $1,001 per bond. The corporation will receive a net price of$993 per bond What is the percentage of underwriting spread per bond? (Relate the dollar pread to the public price c. Which alternative has the larger percentage of spread? Is this the normal lationship between the two types of issues? Solution: Detroit Slugger Bat Company a. Spread=$16.75-$16.00=$0.75 Underwriting spread=$0.75/$16.75=4.48% b. Spread=$1001-$993=$8 Underwriting spread=$8/$1,001=799%or 80%(rounded) C. The stock alternative has the larger percentage spread This is normal because there is more uncertainty in the market associated with a stock offering and investment bankers want to be appropriately compensated -533 Copyright C2005 by The McGra-Hill Companies, Inc
Copyright © 2005 by The McGraw-Hill Companies, Inc. S-533 15-7. The Detroit Slugger Bat Company needs to raise $30 million. The investment banking firm of Kaline, Horton, & Greenberg will handle the transaction. a. If stock is utilized, 1.8 million shares will be sold to the public at $16.75 per share. The corporation will receive a net price of $16 per share. What is the percentage of underwriting spread per share? b. If bonds are utilized, slightly over 30,000 bonds will be sold to the public at $1,001 per bond. The corporation will receive a net price of $993 per bond. What is the percentage of underwriting spread per bond? (Relate the dollar spread to the public price.) c. Which alternative has the larger percentage of spread? Is this the normal relationship between the two types of issues? Solution: Detroit Slugger Bat Company a. Spread = $16.75 – $16.00 = $0.75 % Underwriting spread = $0.75/$16.75 = 4.48% b. Spread = $1,001 – $993 = $8 % Underwriting spread = $8/$1,001 = .799% or .80% (rounded) c. The stock alternative has the larger percentage spread. This is normal because there is more uncertainty in the market associated with a stock offering and investment bankers want to be appropriately compensated
