29) 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
$19.70 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
$17.40 125,000
$17.15 150,000
$16.95 100,000
$16.80 60,000
$16.75 80,000
$16.50 75,000
$16.25 200,000
The proceeds from the IPO be if Luther is selling 1.25 million shares is closest to ________.
A) $18.9 million
B) $22.1 million
C) $21.0 million
D) $20.0 million
Explanation: C)
Price ($)
Number of
Shares Bid
Cumulative
Demand
$19.70 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
$17.40 125,000 995,000
$17.15 150,000 1,145,000
$16.95 100,000 1,245,000
$16.80 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 1.25 million shares
corresponds to a price of $16.80.
So, proceeds = $16.80 × 1,250,000 = $21,000,000
Dif: 2 Var: 36
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
30) What are some of the advantages of going public?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
31) What are some of the disadvantages of going public?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
32) What are some of the highlights of Google’s IPO process?
AACSB Objective: Analytic Skills
Author: SS
32
Question Status: Previous Edition
14.3 IPO Puzzles
1) Stock issued in an IPO usually trades signiicantly higher at the end of the irst day of
trading than the original IPO price.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Newly listed irms tend to perform relatively poorly in the three to ive years after their
IPOs.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) How does the total cost of issuing stock for the irst time compare to the costs of other
securities?
A) substantially larger than the costs for most other securities
B) about the same as the cost for most other securities
C) substantially less than the cost for a few other securities
D) substantially less than the costs for most other securities
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
33
4) Which of the following is a notable puzzle in IPOs?
A) The number of IPOs is highly underestimated.
B) The number of IPOs is highly cyclical.
C) The number of IPOs is highly seasonal.
D) The number of IPOs is almost the same every year.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
5) The ofer price of shares in an IPO is generally less than the price those shares sell for at
the end of the irst trading day. Which of the following parties sufer most from this
situation?
A) the buyers of shares after the initial ofering
B) the underwriters of the IPO
C) the pre-IPO shareholders of the issuing irm
D) the lead underwriter of the IPO
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
6) How does the size of an issue afect the fees charged by underwriters?
A) Although large issues generally have a smaller spread, the total fees for large number of
shares released is smaller than that for smaller issues.
B) Large issues generally have a similar spread to small issues and thus attract much
greater fees.
C) Large issues have a reduced spread, which means that the total fees are generally the
same as for smaller issues.
D) Large issues have substantially larger direct costs and, thus, must charge a larger
spread in order to be proitable for the underwriter.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
34
7) The cost of issuing an IPO in the U.S. is higher than most other security issuance fees. A
typical spread is ________.
A) 5%
B) 6%
C) 7%
D) 8%
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
8) Dusty Corporation is issuing an IPO with an issue price of $15 per share that is expected
to raise about $100 million. Which of the following is likely to be true?
A) The price of the stock will be less than $15 at the close of the irst trading day.
B) The cost of the IPO to Dusty will be about $7 million.
C) The stock will perform very well in the three to ive years after the issue.
D) None of the above is likely to happen.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
9) Which of the following statements concerning the volume and number of IPOs issued
over time is most correct?
A) They are cyclical.
B) They tend to rise over time.
C) They tend to fall over time.
D) They remain approximately the same over time.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
35
10) Underpricing of an IPO would most likely be greatest in which of the following
markets?
A) Australia
B) China
C) Japan
D) United States
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
11) Which of the following is NOT one of the four characteristics of IPOs that puzzle
inancial economists?
A) On average, IPOs appear to be underpriced.
B) The long-run performance of a newly public company (three to ive years from the date
of issue) is superior to the overall market return.
C) The number of issues is highly cyclical.
D) The costs of the IPO are very high, and it is unclear why irms willingly incur such high
costs.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
12) How does IPO pricing puzzle inancial economists?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
13) How do the transaction costs of IPO puzzle inancial economists?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
36
14) What is the general long-run performance of an IPO?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
14.4 Raising Additional Capital: The Seasoned Equity Ofering
1) A cash ofer difers from a rights ofer in that in the latter shares are ofered to both
existing shareholders and investors at large.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) The announcement of an SEO usually raises a stock’s price.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3) Managers will try to protect their existing shareholders by selling new shares at a price
that correctly values or overvalues their irm, leading investors to reason that the
announcement of an SEO indicates that a company is over-valued.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
37
4) Moon Company plans to issue 10 million shares in a seasoned equity ofering. The
owner, Ken Moon, plans to sell 4 million shares as part of the ofering. Which of the
following is true regarding the seasoned equity issue?
A) It is a primary ofering.
B) It is a secondary ofering.
C) Some shares are primary shares and some shares are secondary shares.
D) None of the above is true regarding this seasoned equity ofering.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
5) What is a seasoned equity ofering?
A) the sale of shares by the owners of a company
B) the raising of capital through retained earnings
C) the issuing of shares to the public in a proven private company
D) the issuing of shares by a company at a time after its IPO
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
6) An equity issue that raises new funds for a publicly traded company is called ________.
A) an initial public ofering
B) a seasoned equity ofering
C) an underpriced ofering
D) a secondary ofering
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
38
7) What are the advantages of a rights ofer over a cash ofer when issuing new shares?
A) It enables a irm to attract new investors from outside its current owners.
B) It enables a irm to issue equity without imposing a loss on current shareholders.
C) It enables a irm to access new sources of capital to fund its growth.
D) It enables a irm to attract new investors by ofering them a windfall from the diference
between the price of the issued stock and the price of stock after the ofering.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
8) Big Box retailing has a market capitalization of $500 million and 4 million shares
outstanding. In order to inance its growth, the management of Big Box plans to raise
further capital through a rights issue. All shareholders will be issued ten rights to purchase
ten shares at a price of $1.00 per share. How much money will this raise, if all shareholders
exercise their rights?
A) $20.0 million
B) $40.0 million
C) $60.0 million
D) $80.0 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
9) Valiant Industries has 30 million shares of stock outstanding at a price of $28 per share.
The company wishes to raise more money and plans to do so through a rights issue. Every
existing stockholder will receive one right for each share of stock held. For every four
rights held by the stockholder, they can buy one share at a price of $28. If all rights are
exercised, how much money will be raised in this ofer?
A) $105.0 million
B) $168.0 million
C) $210.0 million
D) $252.0 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
39