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Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
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Page 1
1. Going public establishes a market value for the firm's stock, and it also ensures that a liquid market will continue to
exist for the firm's shares. This is especially true for small firms that are not widely followed by security analysts.
a.
True
b.
False
ANSWER:
False
2. The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial
information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are
potential disadvantages of going public.
a.
True
b.
False
ANSWER:
True
3. Which of the following is generally NOT true and an advantage of going public?
a.
Increases the liquidity of the firm's stock.
b.
Makes it easier to obtain new equity capital.
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
c.
Establishes a market value for the firm.
d.
Makes it easier for owner-managers to engage in profitable self-dealings.
e.
Facilitates stockholder diversification.
ANSWER:
d
4. Which of the following statements about listing on a stock exchange is most CORRECT?
a.
Any firm can be listed on the NYSE as long as it pays the listing fee.
b.
Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do
more business.
c.
Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather
than with the SEC.
d.
The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.
e.
Listing is a decision of more significance to a firm than going public.
ANSWER:
b
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
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Page 3
5. The term "leaving money on the table" refers to the situation where an investment banking house makes a very low bid
for the right to underwrite a firm's new stock offering. The banker is, in effect, "buying the job" with the low bid and thus
not getting all the money his firm would normally earn on the job.
a.
True
b.
False
ANSWER:
False
6. Whereas commercial banks take deposits from some customers and make loans to other customers, the principal
activities of investment banks are (1) to help firms issue new stock and bonds and (2) to give firms advice with regard to
mergers and other financial matters. However, financial corporations often own and operate subsidiaries that operate as
commercial banks and others that are investment banks. This was not true some years ago, when the two types of banks
were required by law to be completely independent of one another.
a.
True
b.
False
ANSWER:
True
7. In its negotiations with its investment bankers, Patton Electronics has reached an agreement whereby the investment
bankers receive a smaller fee now (6% of gross proceeds versus their normal 10%) but also receive a 1-year option to
purchase an additional 200,000 shares at $5.00 per share. Patton will go public by selling $5,000,000 of new common
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
stock. The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year, when the
stock price is forecasted to be $6.50 per share. However, there is a chance that the stock price will actually be $12.00 per
share one year from now. If the $12 price occurs, what would the present value of the entire underwriting compensation
be? Assume that the investment banker's required return on such arrangements is 15%, and ignore taxes.
a.
$1,235,925
b.
$1,300,973
c.
$1,369,446
d.
$1,441,522
e.
$1,517,391
ANSWER:
e
8. The term "equity carve-out" refers to the situation where a firm's managers give themselves the right to purchase new
stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it "carves out"
some of their value.
a.
True
b.
False
ANSWER:
False
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
9. If its managers make a tender offer and buy all shares that were not held by the management team, this is called a
private placement.
a.
True
b.
False
ANSWER:
False
10. Which of the following statements is most CORRECT?
a.
Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
b.
Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
c.
The SEC requires that all private placements be handled by a registered investment banker.
d.
Private placements can generally bring in funds faster than is the case with public offerings.
e.
In a private placement, securities are sold to private (individual) investors rather than to institutions.
ANSWER:
d
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
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Page 6
11. Which of the following statements concerning common stock and the investment banking process is NOT
CORRECT?
a.
If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
b.
Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in
liquidity and reputation probably outweigh the additional costs to the firm.
c.
Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the
business. If stockholders are dissatisfied with management's performance, an outside group may ask the
stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
d.
The announcement of a large issue of new stock could cause the stock price to fall. This loss is called "market
pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new
issue.
e.
The preemptive right gives each existing common stockholder the right to purchase his or her proportionate
share of a new stock issue.
ANSWER:
c
12. Which of the following statements is NOT CORRECT?
a.
"Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for
the firm's shares.
b.
Publicly owned companies have sold shares to investors who are not associated with management, and they
must register with and report to a regulatory agency such as the SEC.
c.
When stock in a closely held corporation is offered to the public for the first time, the transaction is called
"going public," and the market for such stock is called the new issue market.
d.
It is possible for a firm to go public and yet not raise any additional new capital.
e.
When a corporation's shares are owned by a few individuals who own most of the stock or are part of the
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
firm's management, we say that the firm is "closely, or privately, held."
ANSWER:
a
13. To finance its ongoing construction project, Bowen-Roth Inc. will need $5,000,000 of new capital during each of the
next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now
and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years,
when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt
proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value
effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?
a.
$79,425
b.
$83,606
c.
$88,006
d.
$92,406
e.
$97,027
ANSWER:
c
Chapter 18: Initial Public Offerings, Investment Banking, and Financial Restructuring
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