Learning Objective 17-6:
Identify the reasons a company might make an initial public offering of its stock, explain
how stock value is determined, and discuss the significance of market capitalization.
Becoming a Public Corporation
An Initial Public Offering (IPO) is a firm’s first sale of its stock to the public. Corporations
consider various issues before deciding to take the firm public.
A. Going Public Means Selling Part Ownership of the Company
Private owners lose some control when shares are sold to the public. Anyone owning a large
proportion of the company’s shares gains a powerful position in determining who runs the
corporation and how. While an extreme case, this is particularly seen if the stock price falls
and another investor (a corporate raider) mounts a hostile takeover. Corporations are
vulnerable to hostile takeovers if their stock prices become undervalued and the firm’s assets
still have high value.
B. Stock Valuations
Most investors look for long-term value in stocks, rather than their short-term price. In
determining long-term value, investors typically examine the company’s financial health, its
past history of results and future forecasts, its record for managerial performance, and overall
prospects for competing successfully in the coming years.
1. Why Shares Are Different Prices. Share prices can differ substantially from one stock
to another for various reasons. These include the supply and demand of the stock and the
2. Comparing Prices of Different Stocks. When evaluating the price of Pepsi and Coca–
Cola an investor would compare dividends, price earning ratios, and historical
performance consistency over a period of several years, along with indicators of each
1. Pros and Cons of Debt Financing:
a. Long-term Loans. Long-term loans are attractive because the number of parties
involved is limited, they can be arranged quickly, and there is no need for public
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disclosure to account for how the loan is being used. On the other hand, long-term
loans have the disadvantage that borrowers may not easily be able to find lenders and
may face some restrictions as a condition for the loan.
b. Corporate Bonds. The advantage of bonds is that they can raise large amounts of
money when the company needs it. The disadvantage is that they can incur high
administration costs and stiff interest payments.
2. Pros and Cons of Equity Financing. Equity financing is sometimes a favorable option
for companies. Equity financing includes issuing common stock or using the company’s
retained earnings. Issuing new stock can be expensive when dividend payments need to
QUICK QUESTIONS
What is market capitalization?
When might a fall in market capitalization leave a company open to a hostile takeover?
Learning Objective 17-7:
Explain how securities markets are regulated.
Regulating Securities Markets
A. The Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is the regulation and enforcement
agency that oversees the markets’ activities, including the ways securities are issued. The
SEC was created in 1934 to prevent the kinds of abuses that led to the stock market crash in
B. Regulations Against Insider Trading
The SEC also enforces laws against insider trading—the use of special knowledge about a
firm for profit or gain. It is illegal, for example, for an employee of a firm to tell others about
an anticipated event that may affect the value of the firm’s stock before the information is
made public. The SEC offers a reward to any person who provides information leading to a
civil penalty for illegal insider trading.
Along with the SEC’s enforcement efforts, the stock exchanges and securities firms have
QUICK QUESTIONS
In light of the crash in 2009, do you think the SEC is doing a good job regulating
financial markets?
What are the primary roles of the Securities and Exchange Commission?
Use In-Class Activity 2: Up for Debate: What’s Wrong with a Little Inside Scoop?
Time Limit: 30 minutes
HOMEWORK
The Securities and Exchange Commission
Now is a good time to assign Application Exercise 9 from the end-of-chapter materials in the
textbook as homework. This assignment asks students go to www.sec.gov and research how a
new security is approved by the Securities and Exchange Commission.
At Home Completion Time: 30 minutes
HOMEWORK
Researching Insider Trading
Now might be a good time to assign Application Exercise 10 from the end-of-chapter materials
in the textbook as homework. This assignment asks students to research a high profile insider
trading case.
At Home Completion Time: 1 hour
Learning Catalytics is a “bring your own device” student engagement, assessment,
and classroom intelligence system. It allows instructors to engage students in class
with realtime diagnostics. Students can use any modern, web-enabled device
(smartphone, tablet, or laptop) to access it. For more information on using
Learning Catalytics in your course, contact your Pearson Representative.
IN-CLASS ACTIVITIES
In-Class Activity 1: Ice-Breaker: What Should I Buy?
Activity Overview:
This activity asks students to make preliminary purchasing decisions about stocks based on what
they already know about the companies and the stock market in general.
Time Limit: 30 minutes
What to Do:
1. Ask students to assume that they are being given $20,000 to invest in four company stocks,
but that they must choose from the following companies:
McDonald’s Corporation
Microsoft
Corning
2. Divide the class into three-member groups so students can discuss these companies before
making their investment decisions. As students make their decisions, ask them to write down
their rationale for selecting the stocks they did as well as how much they invested in each
one. (15 minutes)
3. Assemble the class as a whole to discuss their choices: (15 minutes)
a. How did students select their stocks?
b. How much did they know about the companies in which they invested?
c. Did the discussion with other group members affect their decisions?
d. What factors affected the allocation of the $20,000?
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Don’t Forget:
Some students will know more about investing than others.
Wrap-Up:
Bring the activity to a close by discussing the importance of doing ―homework‖ on a particular
company before investing in it. Very few students (or potential investors) would know enough
about any of the above companies to make a sound investment. Company reputation can mean a
lot when an individual chooses to make an investment, but this type of investing is not always
prudent.
In-Class Activity 2: Up for Debate: What’s Wrong with a Little Inside Scoop?
Activity Overview:
This activity asks students to debate the pros and cons and the key issues surrounding insider
trading.
Time Limit: 30 minutes
What to Do:
1. Divide the class into four-member groups and ask each group to make a list of the
a. Would insider trading actually make the market more efficient?
b. Who is really hurt in most cases of insider trading?
c. Why is insider trading illegal?
2. Assemble the class as a whole and debate the pros and cons of insider trading. (15 minutes)
Don’t Forget:
ANSWERS FOR END OF CHAPTER ACTIVITIES
QUESTIONS FOR REVIEW
17-1. Explain the concept of the time value of money.
The time value of money stems from the principle of compound growth. With each
17-2. Would you rather buy individual stocks or invest in mutual funds? What is the difference,
and why would you favor one over the other?
Answers will vary, but students should justify their opinions with logic. For instance, mutual
17-3. What is a corporate bond? Why would a company use bonds as a source of financing?
Corporate bonds have a number of characteristics. The bond indenture spells out the
17-4. How does the market value of a stock differ from the book value of a stock?
The book value of a stock is determined by dividing the shareholders’ equity in the firm by
17-5. How do firms meet their needs through debt financing and equity financing?
In order to fund expansion, firms might use debt or equity financing. Debt financing is when
QUESTIONS FOR ANALYSIS
17-6. Research several stocks online. You will notice that they have continually fluctuated in
price. What might be the reason for this? Is a higher-priced stock a better investment than a
lower-priced stock? What factors would you consider in purchasing stocks?
Stock prices can vary enormously depending upon a number of factors, including the
company’s recent performance, future expectations, changes in the company’s competition,
17-7. Suppose that you are a business owner and you need new equipment and immediate
funds to meet short-term operating expenses. From what sources could you gain the capital
you need, and what are some of the characteristics of these sources? Are you limited by your
form of doing business, and if so, how?
A business owner in need of short-term funds can either opt for debt financing or equity
financing. Debt financing in this case would most likely take the form of an operating line of
credit or short-term secured loan collateralized by the equipment or even by inventory or
17-8. Suppose that you are a business owner and you are seeking funds for expansion. From
what sources could you gain the capital you need, and what are some of the characteristics of
these sources? Are you limited by your form of doing business, and if so, how? How do these
kinds of funding sources differ from funding sources for new equipment and short-term
operating expenses?
A business owner in need of capital can either opt for debt financing or equity financing.
Debt financing includes taking on long-term loans or issuing corporate bonds. The advantage
of long-term loans is that there are relatively few parties involved, so they can be often
quickly arranged. Bonds are slower to arrange, and can have high service interest rates
APPLICATION EXERCISES
17-9. Go to http://www.sec.gov and research how a new security is approved by the Securities
and Exchange Commission. What is the process involved and how long would it take? Next,
contact a financial institution such as Merrill Lynch and request information about their
procedures for issuing or reselling new securities. Share this information with your
classmates.
When a corporation wants to offer a new security, it must file a registration statement with
the SEC that contains the following information: the name and description of the corporation;
a biography of directors and officers (President, CEO, CFO, etc.); the financial stakes of all
insiders, directors, and officers and anyone holding more than 10 percent of the corporation’s
securities; full and complete financial statements; the type of security for sale and how the
money raised will be used; and disclosure of any previous legal proceedings that may impact
17-10. There have been a number of high profile cases in recent years concerning insider trading.
Use an online search to find a case involving insider trading. What is insider trading? Who
was accused of insider trading and what was their relationship to the company? Were they
convicted of insider trading, and if so, what was the penalty? Finally, how could the person
accused of insider trading have avoided the charges?
The Wall Street Journal would be an excellent resource. Unfortunately, insider trading is a
BUILDING A BUSINESS: CONTINUING TEAM EXERCISE 17-11 TO 17-15
(Learning Objectives 5 and 6 – AACSB – interpersonal relations and teamwork, analytical
and reflective thinking, application of knowledge)
Students should be encouraged to undertake a careful analysis of the pros and cons of debt and
equity financing with an emphasis on a realistic analysis of the markets.
TEAM EXERCISE: MARKETS UPS AND DOWNS 17-16 TO 17-19
(Learning Objective 6 – AACSB – interpersonal relations and teamwork, analytical and
reflective thinking, application of knowledge)
Many factors, both internal and external, affect stock prices, such as the firm’s earnings, layoffs,
labor problems, management issues, and mergers, as well as the state of the industry in general
and any threats of political crisis, weather conditions, interest rate changes, and inflation and
unemployment data and forecasts.
Global corporations are often affected by numerous external factors, sometimes including factors
that have little impact on our own domestic market. Some external factors, such as oil prices, can
impact stock in the very long run. In some cases, however, a mere change in CEO can impact the
price of a stock; and, this impact is likely to be shorter-lasting. Political or legal changes within a
country can impact businesses. Various actions from competitors—external factors—can be both
long- and short-lasting, depending on those actions.
EXERCISING YOUR ETHICS: ARE YOU ENDOWED WITH GOOD JUDGEMENT?
(Learning Objective 2 – AACSB – ethical understanding and reasoning, reflective
thinking)
17-20. Why might a conservative versus risky choice be different at a not-for-profit organization
than at a for-profit organization?
17-21. What are the main ethical issues in this situation?
17-22. What options/alternatives/actions would you recommend to the board?
Answers will vary. Given the purpose of the organization and the intrinsic value of the funds
being invested, many students may opt to remain conservative in their investment strategies.
CASES:
FIRE ON THE GROUND
(Learning Objective 3 – AACSB – ethical understanding and reasoning, reflective
thinking)
17-23. When the Coser and Ongaratto brothers started Fogo de Chão, what were their primary
sources of financing?
17-24. After the Coser brothers acquired the Ongaratto brothers’ shares of the company, they
brought in GP Investments, a Brazilian venture capital firm. What are the advantages and
disadvantages of using venture capital to build a business venture?
Venture capital provides private funds from the investment firm. This can stabilize the
financial situation for a business, allow it to pay down debt, or provide funds that enhance its
17-25. After the sale of Fogo de Chão to Thomas H. Lee Partners, the board and management
team decided to issue an IPO of common stock. What were the goals of the IPO?
17-26. What are the benefits of an IPO as a source of financing? What other options did the
company have?
The benefits of an IPO include reaching far more potential investors, thus providing access to
a larger pool of funds. Debt financing and equity financing are the two options of acquiring
17-27. Would you consider investing in Fogo de Chão? Why, or why not?
Answers will vary. Students should examine numerous factors, not simply the performance
of the stock since the IPO. These factors include the company’s overall financial health, its
17-28. If an investor had bought stock during the IPO, what would that investment be worth
today?
TIME TO GOGO?
(Learning Objectives 4, 5, and 6 – AACSB – analytical and reflective thinking, application
of knowledge)
17-29. Given the risk, what would motivate an investor to purchase stock in Gogo?
17-30. Why would Gogo sell stock rather than taking on additional debt financing? Do you think
that this was a good decision?
They would sell stock because they are already highly leveraged and probably would not
17-31. What role did underwriters, such as Morgan Stanley, JPMorgan, and UBS, play in the
IPO?
Underwriters buy and assume liability for new securities. This provided Gogo with 100
17-32. Use a Web source, such as Yahoo! Finance or www.nasdaq.com to obtain the current
price of Gogo stock. What has happened to the price of the stock over the last six months?
What about the last two years?
17-33. Using the data provided from the web source in the previous step, is Gogo a small– or
large-cap stock? How would this affect the risk associated with this investment?
Answers will vary depending on when the student researches the stock. Students will also
CRAFTING A BUSINESS PLAN
PART 6: FINANCIAL ISSUES
Assignment Overview:
The final part of the business plan project asks students to consider how they’ll finance their
business as well as how to create an executive summary for their plan. Remind students that
although the executive summary is the final step in the project, it should be placed at the
beginning of their completed business plans. Encourage your students to be concise as they write
the executive summary, as investors look at the summary before reading the details of the plan.
Because this is the final part of the plan, you will probably want to ask students to submit not just
Part 6, but the entire plan at this point.
Files to Provide Students:
For this part of the project, students will be asked to complete Part 6: Financial Issues.
STUDENT BUSINESS PLAN PROJECT TEMPLATE
PART 6: FINANCIAL ISSUES
STARTUP COSTS
How much money will you need to get your business started?
Hint: Refer back to Part 5 of the plan, where you analyzed the costs involved in running your
business. Approximately, how much will you need to get your business started?
FINANCING
How will you finance your business? For example, will you seek out a bank loan? Borrow
from friends? Sell stocks or bonds initially or as your business grows?
Hint: Refer to Chapter 16 for information on securities, such as stocks and bonds. Refer also to
Appendix I: Financial Risk and Risk Management and Chapter 3 for more information on
sources of short-term and long-term funds.
EXECUTIVE SUMMARY
Now, create an executive summary for your business plan. The executive summary should
be brief—no more than two pages long—and should cover the following points:
The name of your business
Where your business will be located
Hint: At this point, you’ve already answered all these questions so what you need to do here is
put the ideas together into a “snapshot” format. The executive summary is really a sales pitch—