13) David found a company and goes through the investment rounds shown below:
Round Source Price Number of Shares
Series A Self $0.50 325,000
Series B Angel $1.00 475,000
Series C Venture Capital $1.50 200,000
Series D Venture Capital $2.25 350,000
He decides to take the company public through an IPO, issuing 2 million new shares.
Assuming that he successfully completes the IPO, the net income for the next year is
estimated to be $8 million. His banker informs him that the price of shares should be set
using average price-earnings ratios for similar businesses, which is 14. What share of the
company will David own after the IPO?
A) 10%
B) 13%
C) 15%
D) 19%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
14) In its IPO, Jillian’s Imprints, a small publishing house, ofered stock at a price of $10.00
per share. The underwriters of this IPO had a spread of 6.5% per share. If 2 million shares
were sold, what funds did Jillian’s receive from the IPO?
A) $5.61 million
B) $18.70 million
C) $20.57 million
D) $22.44 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
21
15) The founders and owners of a private company have funded it through the following
rounds of investment:
Round Source Price Number of Shares
Series A Self $1.00 100,000
Series B Angel $1.00 225,000
Series C Venture Capital $1.25 375,000
The owners decide to take the company public through an IPO, issuing 1 million new
shares. Assuming that they successfully complete the IPO, the net income for the next year
is estimated to be $5 million. The price of shares is set using average price-earnings ratios
for similar businesses of 16. What will be the IPO price per share?
A) $12
B) $24
C) $9
D) $47
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
22
16) The founders and owners of a private company have funded it through the following
rounds of investment:
Round Source Price Number of Shares
Series A Self $1.00 100,000
Series B Angel $1.00 225,000
Series C Venture Capital $1.25 350,000
The owners decide to take the company public through an IPO, issuing 1 million new
shares. Assuming that they successfully complete the IPO, the net income for the next year
is estimated to be $6 million. The price of shares is set using average price-earnings ratios
for similar businesses of 15. What portion of the company will be owned by the angel
investor after the IPO?
A) 10%
B) 13%
C) 19%
D) 24%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
17) What is the major reason that underwriters tend to ofer stocks in an IPO at a price that
is below that which the market will pay?
A) to gain from the rise in value of any stocks they hold after the IPO
B) to reduce their exposure to losses from unsold stock
C) to beneit from greenshoe provisions
D) to increase their spread
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
23
18) The founder of a company currently holds 12 million of the 15 million shares in that
company. She considers an IPO where she sells a mix of primary shares and 2 million of her
own secondary shares for $16 per share. If she wants to retain a 70% ownership of the
company, how much money can she raise in this IPO?
A) $9 million
B) $12 million
C) $15 million
D) $24 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
19) Which of the following statements is FALSE?
A) The process of selling stock to the public for the irst time is called a seasoned equity
ofering (SEO).
B) Public companies typically have access to much larger amounts of capital through the
public markets.
C) By going public, companies give their private equity investors the ability to diversify.
D) The two advantages of going public are greater liquidity and better access to capital.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
24
20) Which of the following statements is FALSE?
A) Once a company goes public, it must satisfy all of the requirements of public companies.
B) Organizations such as the Securities and Exchange Commission (SEC), the securities
exchanges (including the NYSE and the NASDAQ), and Congress (through the Sarbanes-
Oxley Act of 2002) adopted new standards that focused on more thorough inancial
disclosure, greater accountability, and more stringent requirements for the board of
directors.
C) The major advantage of undertaking an IPO is also one of the major disadvantages of an
IPO: When investors diversify their holdings, the equity holders of the corporation become
more concentrated.
D) Several high proile corporate scandals during the early part of the twenty-irst century
prompted tougher regulations designed to address corporate abuses.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
21) Which of the following statements is FALSE?
A) After deciding to go public, managers of the company work with an underwriter, an
investment banking irm that manages the ofering and designs its structure.
B) The shares that are sold in the IPO may either be new shares that raise new capital,
known as a secondary ofering, or existing shares that are sold by current shareholders (as
part of their exit strategy), known as a primary ofering.
C) Many IPOs, especially the larger oferings, are managed by a group of underwriters.
D) In an IPO, a irm ofers a large block of shares for sale to the public for the irst time.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
25
22) Which of the following statements regarding best eforts IPOs is FALSE?
A) For smaller IPOs, the underwriter commonly accepts the deal on this basis.
B) The underwriter does not guarantee that the stock will be sold, but instead tries to sell
the stock for the best possible price.
C) Often these arrangements have an all-or-none clause: either all of the shares are sold in
the IPO, or the deal is called of.
D) If the entire issue does not sell out, the underwriter is on the hook.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
23) Which of the following statements regarding irm commitment IPOs is FALSE?
A) If the entire issue does not sell out, the remaining shares must be sold at a lower price
and the underwriter must take the loss.
B) The underwriter purchases the entire issue (at an ofer price) and then resells it at a
slightly higher price to interested investors.
C) It is the most common underwriting arrangement.
D) The underwriter guarantees that it will sell all of the stock at the ofer price.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
26
24) Which of the following statements is FALSE?
A) In recent years, the investment banking irm of WR Hambrecht + Company has
attempted to change the IPO process by selling new issues directly to the public using an
online auction IPO mechanism called Open IPO.
B) The lead underwriter is the primary banking irm responsible for managing the deal. The
lead underwriter provides most of the advice and arranges for a group of other
underwriters, called the syndicate, to help market and sell the issue.
C) Because of the potential conlict of interest, the underwriter will not make a market in
the stock after the issue.
D) The SEC requires that companies prepare a registration statement, a legal document
that provides inancial and other information about the company to investors, prior to an
IPO. Company managers work closely with the underwriters to prepare this registration
statement and submit it to the SEC.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
25) As part of the registration statement, the preliminary prospectus circulates to investors
before the stock is ofered. This preliminary prospectus is also called a(n) ________.
A) IPO iling
B) 10-K iling
C) blue whale
D) red herring
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
26) Which of the following statements is FALSE?
A) Once the issue price (or ofer price) is set, underwriters may invoke another mechanism
that allows them to sell extra shares of more successful oferings—the over-allotment
allocation.
B) Before the ofer price is set, the underwriters work closely with the company to come up
with a price range that they believe provides a reasonable valuation for the irm.
C) Before an IPO, the company prepares the inal registration statement and inal
prospectus containing all the details of the IPO, including the number of shares ofered and
the ofer price.
D) In a cash ofer, a irm ofers the new shares only to existing shareholders.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
27) Which of the following statements is FALSE?
A) Underwriters appear to use the information they acquire during the book-building stage
to intentionally underprice the IPO, thereby reducing their exposure to losses.
27
B) The green shoe option restricts an underwriter to issue more stock at the IPO ofer
price.
C) The lead underwriter usually makes a market in the stock by matching buyers and
sellers and assigns an analyst to cover it.
D) In most cases, the existing shareholders are subject to a 180-day lockup; they cannot
sell their shares for 180 days after the IPO. Once the lockup period expires, they are free to
sell their shares.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
28
28) Luther Industries is in the process of selling shares of stock in an auction IPO. At the
end of the bidding period, Luther’s investment bank has received the following bids:
Price ($)
Number of
Shares Bid
$19.40 50,000
$19.25 25,000
$19.10 25,000
$19.00 100,000
$18.75 125,000
$18.50 75,000
$18.25 150,000
$18.00 240,000
$17.75 80,000
$17.60 125,000
$17.35 150,000
$17.15 100,000
$16.90 60,000
$16.75 80,000
$16.50 75,000
$16.25 200,000
What will the ofer price of these shares be if Luther is selling 1 million shares?
A) $17.15
B) $17.60
C) $17.35
D) $16.75
Explanation: C)
Price ($)
Number of
Shares Bid
Cumulative
Demand
$19.40 50,000 50,000
$19.25 25,000 75,000
$19.10 25,000 100,000
$19.00 100,000 200,000
$18.75 125,000 325,000
$18.50 75,000 400,000
$18.25 150,000 550,000
$18.00 240,000 790,000
$17.75 80,000 870,000
$17.60 125,000 995,000
$17.35 150,000 1,145,000
$17.15 100,000 1,245,000
$16.90 60,000 1,305,000
$16.75 80,000 1,385,000
$16.50 75,000 1,460,000
$16.25 200,000 1,660,000
By looking at cumulative demand, we see that a cumulative demand of 1 million shares
corresponds to a price of $17.35.
Dif: 2 Var: 12
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
30