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Chapter 18 - Issuing Capital and the Investment Banking Process
CHAPTER 18 – ISSUING CAPITAL AND THE INVESTMENT BANKING PROCESS
questions
LG1 1. Describe the various sources of capital funding available to new and small firms.
Most new and small firms finance their business assets by borrowing funds from private or
LG1 2. What process do banks use to evaluate bank loans to small versus mid market business firms?
Low profitability has caused many banks to build small-business scoring models similar to, but more
LG1 3. What is the difference between a spot loan and a loan commitment?
Spot loans are loans in which the firm would receive the funds as soon as the bank approved the loan.
LG1 4. Why do banks charge up-front fees and back-end fees on loan commitments?
In return for making the loan commitment, the bank may charge an up-front fee (or facility fee)
LG1 5. What is the difference between a fixed-rate and a floating-rate loan?
With fixed-rate loans, the firm makes fixed interest payments over the life of the loan. With floating-
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LG1 6. What types of programs does the Small Business Administration offer to new and small
businesses? Under what conditions would a new or small firm use each program?
For qualified new and small firms that cannot obtain long-term financing on reasonable terms
from banks or other financial institutions, the SBA offers a basic loan guarantee program.
LG2 7. What is venture capital?
Venture capital is a professionally managed pool of money used to finance new and often high-
risk firms. Venture capital is generally provided by investment institutions or private individuals
LG2 8. What are the different types of venture capital firms? How do institutional venture capital firms
differ from angel venture capital firms?
Institutional venture capital firms’ sole purpose is to find and fund the most promising new firms.
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Chapter 18 - Issuing Capital and the Investment Banking Process
LG2 9. What are the advantages and disadvantages to a new or small firm of getting capital funding from a
venture capital firm?
Venture capital firms receive many unsolicited proposals of funding from new and small firms. The
LG1 10. As a new or small firm considers going public what must the owners consider?
In making the decision to go from a private to a public firm, managers must consider the benefits
versus the costs of doing so. As mentioned previously, a major benefit of going public is that the
firm will have to a new, larger pool of equity capital than is available from any previous source
proceeds do not actually become available to the newly public firm. Add to these financial costs
a substantial demand for time from the firm’s owners during the IPO process. That is, the firm’s
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Chapter 18 - Issuing Capital and the Investment Banking Process
LG3 11. Describe the various sources of capital funding available to public firms.
In contrast to small and new firms that can only get capital funding from mainly private sources,
LG3 12. What is the difference between a direct and an indirect placement of commercial paper?
Commercial paper is sold to investors either directly (about 84 percent of all issues in 2013—see
LG3 13. Can a public firm with a lower-than-prime credit rating issue commercial paper?
Commercial paper issuers with lower than prime credit ratings often back their commercial paper
issues with lines of credit from commercial banks. In these cases, banks agree to make the
LG4 14. How does a best efforts underwriting differ from a firm commitment underwriting? If you
operated a company issuing stock for the first time, which type of underwriting would you prefer?
Why might you still choose the alternative?
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LG4 15. How does a competitive sale of corporate bonds differ from a negotiated sale? Which type of
underwriting would you prefer? Why might you still choose the alternative?
The investment bank can purchase the bonds through competitive bidding against other
LG4 16. How does a public offering of debt or equity securities issued by a public firm differ from a
private placement?
Most often, corporate bonds are offered publicly through investment banks acting as
of 1934 requires publicly traded securities to be registered with the Securities and Exchange
LG4 17. What are the net proceeds, gross proceeds, and underwriter’s spread? How does each affect the
funds received by a public firm when debt or equity securities are issued?
LG4 18. Why would an investment bank use a syndicate to assist in underwriting debt or equity securities?
Once an issue is arranged and its terms set, each syndicate member is assigned a given number of
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LG4 19. What is the difference between a prospectus and a red herring prospectus?
At the same time that the issuing firm and its investment bank prepare the registration statement
LG4 20. What is a shelf registration? Why would a public firm want to issue securities using a shelf
registration?
To reduce registration time and costs, yet still protect the public by requiring issuers to disclose
information about the firm and the security to be issued, the SEC passed a rule in 1982 allowing
for “shelf registration.” A shelf registration allows firms that plan to offer multiple issues of stock
over a two-year period to submit one registration statement as described previously (called a
Problems
basic
problems
LG1 18-1 Calculating Fees on a Loan Commitment You have approached your local bank for a start-up
loan commitment for $250,000 needed to open a computer repair store. You have requested that the
term of the loan be one year. Your bank has offered you the following terms: size of loan commitment
= $250,000, term = one year, up-front fee = 50 basis points, back-end fee = 75 basis points. If you
take down 80 percent of the total loan commitment, calculate the total fees you would pay on this
loan commitment.
LG1 18-2 Calculating Fees on a Loan Commitment Calculate the total fees a firm would have to
pay when its bank offers the firm the following loan commitment: A loan commitment of $4.25
million with an up-front fee of 75 basis points and a back-end fee of 25 basis points. The take
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LG4 18-3 Calculating Costs of Issuing Stock Husker’s Tuxedo’s, Inc. needs to raise $250 million to
finance its plan for nationwide expansion. In discussions with its investment bank, Husker’s learns
that the bankers recommend an offer price (or gross price) of $35 per share and they will charge an
underwriter’s spread of $1.75 per share. Calculate the net proceeds to Husker’s from the sale of stock.
How many shares of stock will Husker’s need to sell in order to receive the $250 million they need?
LG4 18-4 Calculating Costs of Issuing Stock Don’s Captain Morgan, Inc. needs to raise $12.5 million to
finance plant expansion. In discussions with its investment bank, Don’s learns that the bankers
recommend an offer price (or gross proceeds) of $25.50 per share and Don’s will receive $23.75 per
share. Calculate the underwriter’s spread on the issue. How many shares of stock will Don’s need to
sell in order to receive the $12.5 million they need?
LG4 18-5 Calculating Costs of Issuing Debt The Fitness Studio, Inc., with the help of its investment
bank, recently issued $43.125 million of new debt. The offer price (and face value) on the debt was
$1,000 per bond and the underwriter’s spread was 7 percent of the gross proceeds. Calculate the
amount of capital funding The Fitness Studio, Inc. raised through this debt offering.
LG4 18-6 Calculating Costs of Issuing Debt Harper’s Dog Pens, Inc., with the help of its investment
bank recently issued $191.5 million of new debt. The offer price on the debt was $1,000 per bond and
the underwriter’s spread was 5 percent of the gross proceeds. Calculate the amount of capital funding
Harper’s Dog Pens, Inc. raised through this bond issue.
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