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Chapter 15: Investment Banking: Public and Private Placement
15-11
Wrigley Corporation
a. Spread = $15.70 – $15.00 = $0.70
% underwriting spread = $.70$15.70 = 4.46%
b. Spread = $1,001 – $992 = $9
% underwriting spread = $9/$1,001 = .899%
to be appropriately compensated.
11. Secondary offering (LO2) Kevin’s Bacon Company Inc. has earnings of $6 million with
2,000,000 shares outstanding before a public distribution. Five hundred thousand shares
will be included in the sale, of which 300,000 are new corporate shares, and 200,000 are shares
currently owned by Ann Fry, the founder and CEO. The 200,000 shares that Ann is selling are
referred to as a secondary offering and all proceeds will go to her.
The net price from the offering will be $15.50 and the corporate proceeds are expected
to produce $1.5 million in corporate earnings.
a. What were the corporation’s earnings per share before the offering?
15-11. Solution:
Kevin’s Bacon Company
a. Earnings per share before the stock issue
Total Earnings
Chapter 15: Investment Banking: Public and Private Placement
Before offering $6,000,000
Corporate shares outstanding
Before offering 2,000,000
Chapter 15: Investment Banking: Public and Private Placement
15-13
$110,000 loss on market stabilization
13. Underwriting costs (LO2) Trump Card Co. will issue stock at a retail (public) price of
$30. The company will receive $27.60 per share.
a. What is the spread on the issue in percentage terms?
b. If the firm demands receiving a net price only $1.50 below the public price suggested in
part a, what will the spread be in percentage terms?
c. To hold the spread down to 3 percent based on the public price in part a, what net
amount should Trump Card Co. receive?
15-13. Solution:
Trump Card Company
a.
$ Spread $2.40 8%
Public Price $30
==
b.
$ Spread $1.50 5%
Public Price $30
==
14. Underwriting costs (LO2) Winston Sporting Goods is considering a public offering of
common stock. Its investment banker has informed the company that the retail price will be $18
per share for 600,000 shares. The company will receive $16.50 per share and will incur
$150,000 in registration, accounting, and printing fees.
a. What is the spread on this issue in percentage terms? What are the total expenses of the
issue as a percentage of total value (at retail)?
b. If the firm wanted to net $18 million from this issue, how many shares must be sold?
Chapter 15: Investment Banking: Public and Private Placement
15-14. Solution:
Winston Sporting Goods
a. $18 – $16.50 = $1.50 spread $1.50/$18.00 = 8.33% spread
Total expenses = ($1.50 x 600,000 shares)
Chapter 15: Investment Banking: Public and Private Placement
15-15
Assume, in assessing the initial P/E ratio, the investment banker will first determine the
appropriate industry P/E based on the Standard & Poor’s 500 Index. Then ½ point will be
added to the P/E ratio for each case in which Rodgers is superior to the industry norm, and
½ point will be deducted for an inferior comparison. On this basis, what should the initial
P/E be for Rodgers Homebuilding?
15-15. Solution:
Rodgers Homebuilding
80% of the Standard and Poor’s 500 Stock Index =
80% 25 = 20
Industry Comparisons
Growth rate in earnings per share-superior + ½
16. Dividend valuation model for new public issue (LO1) The investment banking firm of
Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern
Physics Corporation. Dividends (D1) at the end of the current year will be $1.44. The
growth rate (g) is 8 percent and the discount rate (Ke) is 12 percent.
a. Using Formula 10–9 in Chapter 10, what should be the price of the stock to the public?
b. If there is a 6 percent total underwriting spread on the stock, how much will the issuing
corporation receive?
c. If the issuing corporation requires a net price of $34.50 (proceeds to the corporation)
and there is a 6 percent underwriting spread, what should be the price of the stock to the
public? (Round to two places to the right of the decimal point.)
15-16. Solution:
Chapter 15: Investment Banking: Public and Private Placement
15-16
Einstein & Co.
1
o
e
D$1.44 $1.44
a. P $36
K g .12 .08 .04
= = = =
−−
Net price
c. Necessary public price (1 underwriting spread)
$34.50 $34.50 $36.70
(1 .06) .94
=
−
==
−
17. Comparison of private and public debt offering (LO1) The Landers Corporation needs
to raise $1 million of debt on a 25-year issue. If it places the bonds privately, the interest
rate will be 11 percent. Thirty thousand dollars in out-of-pocket costs will be incurred. For
a public issue, the interest rate will be 10 percent, and the underwriting spread will be 4
percent. There will be $100,000 in out-of-pocket costs. Assume interest on the debt is paid
semiannually, and the debt will be outstanding for the full 25 year period, at which time it
will be repaid.
Which plan offers the higher net present value? For each plan, compare the net amount
of funds initially available—inflow—to the present value of future payments of interest and
principal to determine net present value. Assume the stated discount rate is 12 percent
annually. Use 6 percent semiannually throughout the analysis. (Disregard taxes.)
15-17. Solution:
Landers Corporation
Private Placement
Chapter 15: Investment Banking: Public and Private Placement
Present value of future interest payments
interest payments (semiannually) = 11%/2 = 5.5%
Present value of lump-sum payment at maturity
PV = FV PVIF (n = 50, i = 6%)
15-17. (Continued)
Total present value of interest and maturity payments
$866,910
54,000
$920,910 total present value
+
The net present value equals the net amount to Landers minus the
present value of future payments.
$970,000 net amount to Landers
920,910 present value of future payments
$ 49,090 net present value (private offering)
−
Public Issue
Chapter 15: Investment Banking: Public and Private Placement
$1,000,000 debt
40,000 4% spread
100,000 out-of-pocket costs
$ 860,000 net amount to Landers
−
−
Present value of future interest payments
Present value of lump-sum payment at maturity
15-17. (Continued)
Total present value of interest and maturity payments
$788,100
54,000
$842,100 total present value
+
Net present value equals the net amount to Landers minus the
present value of future payments.
Chapter 15: Investment Banking: Public and Private Placement
$860,000 net amount to Landers
842,100 present value of future payments
$ 17,900 net amount to Landers
−
The private placement has the higher net present value ($49,090
vs. $17,900)
18. Features associated with a stock distribution (LO3) Midland Corporation has a net
income of $15 million and 6 million shares outstanding. Its common stock is currently
selling for $40 per share. Midland plans to sell common stock to set up a major new
production facility with a net cost of $21,660,000. The production facility will not produce
a profit for one year, and then it is expected to earn a 15 percent return on the investment.
Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public
for $38 per share with a spread of 5 percent.
a. How many shares of stock must be sold to net $21,660,000? (Note: No out-of-pocket
costs must be considered in this problem.)
b. Why is the investment banker selling the stock at less than its current market price?
c. What are the earnings per share (EPS) and the price-earnings ratio before the issue
(based on a stock price of $40)? What will be the price per share immediately after the
sale of stock if the P/E stays constant?
d. Compute the EPS and the price (P/E stays constant) after the new production facility
begins to produce a profit.
e. Are the shareholders better off because of the sale of stock and the resultant
investment? What other financing strategy could the company have tried to increase
earnings per share?
15-18. Solution:
Midland Corporation
a. $21,660,000 net amount to be raised.
Determine net price to the corporation
$38.00 public price
1.90 5% spread
$36.10 net price
−
Chapter 15: Investment Banking: Public and Private Placement
15-20
Determine number of shares to be sold
$21,660,000 600,000 shares
$36.10 =
15-18. (Continued)
b. The new shares will increase the total number of shares
value, the investment banker is attempting to attract
investors into this temporarily dilutive situation. The
c. EPS = $15,000,000/6,000,000 = $2.50
