Principles of Finance 6e Chapter 3
Besley/Brigham
3-1
CHAPTER 3
ANSWERS
3-1 A financial market is a mechanism that brings borrowers (those who need funds) and lenders
3-2 It would be difficult for firms to raise capital. Thus, capital investment would slow down,
3-3 The prices of goods and services must cover their costs. Costs include labor, materials, and
3-4 No, the real value of a security is determined by the equilibrium forces of an efficient market.
3-5 a. Listing a stock on the organized exchange would increase name recognition and prestige
and therefore probably increase a company’s ability to attract capital. Flotation costs might
decrease as the ability to float an issue easily increases. It should be remembered that
3-6 Investment bankers must investigate the firms whose securities they sell, simply because, if an
issue is overvalued and suffers marked price declines after the issue, the banker will find it
3-7 A firm would desire a wider distribution of its stock for the following reasons:
(1) To increase the size of its market for future stock issues.
Chapter 3 Principles of Finance 6e
Besley/Brigham
3-2
3-8 The principal advantages to listing on a physical stock exchange include: (1) the publicity and
3-9 First, remember that the NASDAQ market is an “electronic” marketplace rather than a physical
location like the New York Stock Exchange (NYSE). Both Microsoft and Intel manufacture
───────────────────────────────────────────────────────
SOLUTIONS
3-1 a. $7.50 per share
Gross proceeds = (3,000,000)($7.50) = $22,500,000
Net profit = $22,500,000 – $21,000,000 – $450,000 = $1,050,000
3-2 a. Flotation costs = $39,000,000(0.04) = $1,560,000
Principles of Finance 6e Chapter 3
Besley/Brigham
3-3 Net proceeds per share = $20(1 – 0.07) = $18.60.
$20
3-4
shares 000,000,5
0.1) – $12(1
000,000,54$
shares of Number ==
$75,000,000 $466,000
$1,000(1 – 0.03)
+
If the firm issues 77,800 bonds, the amount it will be able to use is
Proceeds = 77,800($1,000) – 77,800($1,000)(0.03) – $466,000
= $77,800,000 – $2,800,000 = $75,000,000
00$150,000,0
Chapter 3 Principles of Finance 6e
Besley/Brigham
b. If the firm needs $42 million for growth, the amount of stock it will have to issue is
d. The founders might decide to issue non-voting shares of stock.
3-10 Integrative Problem
a. A financial market is one in which financial assets are bought and sold. There are many
different types of financial markets, each one dealing with a different type of financial asset,
serving a different set of customers, or operating in a different part of the country. Financial
d. Transfers of capital can be made (1) by direct transfer of money and securities, (2) through
an investment banker, or (3) through a financial intermediary. In a direct transfer, a
business sells its stocks or bonds directly to investors (savers), without going through any
type of institution. The business borrower receives dollars from the savers, and the savers
receive securities (bonds or stock) in return.
000,000,50$
000,000,42$
issue stock the of Amount =
=
Principles of Finance 6e Chapter 3
Besley/Brigham
3-5
e. The physical, or organized security exchanges are formal organizations having tangible,
physical locations and trading in designated securities. There are exchanges for stocks,
bonds, commodities, futures, and options. The most famous exchange in the United States
f. The basic process is essentially the same as for established firms that are publicly traded.
Stage I decisions include those that the firms make concerning the size of the issue, the
type of securities to be issued, and the selection of an investment banker. Stage II
decisions include those made with the advice of the investment banker—reevaluating the
g. To net the firm $25 million, the amount of the IPO must be:
1 – 0.097
The number shares that must be issued is
$28,000,000
Number of shares =
$8.00
= 3,500,000 shares
Chapter 3 Principles of Finance 6e
Besley/Brigham
3-6
3-11 Computer-Related Problem
a.
INPUT DATA:
KEY OUTPUT:
Amount needed by the firm:
$500,000
Issue amount ($):
$540,000
Flotation costs (in decimal form):
6.50%
# of shares:
13,500
Other issuing expenses:
$4,900
Stock price per share:
$40.00
Underwriting fees
$35,100
Other expenses
$4,900
Total issuing costs
$40,000
Amt of usable funds
$500,000
b.
INPUT DATA:
KEY OUTPUT:
Amount needed by the firm:
$500,000
Issue amount ($):
$561,000
Flotation costs (in decimal form):
10.00%
# of shares:
14,025
Other issuing expenses:
$4,900
Stock price per share:
$40.00
Underwriting fees
$56,100
Other expenses
$4,900
Total issuing costs
$61,000
Amt of usable funds
$500,000
c.
INPUT DATA:
KEY OUTPUT:
Amount needed by the firm:
$500,000
Issue amount ($):
$550,000
Flotation costs (in decimal form):
8.20%
# of shares:
13,750
Other issuing expenses:
$4,900
Stock price per share:
$40.00
Underwriting fees
$45,100
Other expenses
$4,900
Total issuing costs
$50,000
Amt of usable funds
$500,000
d.
INPUT DATA:
KEY OUTPUT:
Amount needed by the firm:
$450,000
Issue amount ($):
$487,524
Flotation costs (in decimal form):
6.50%
# of shares:
12,188
Other issuing expenses:
$5,835
Stock price per share:
$40.00
Underwriting fees
$31,689
Other expenses
$5,835
Total issuing costs
$37,524
Amt of usable funds
$450,000
e.
INPUT DATA:
KEY OUTPUT:
Amount needed by the firm:
$450,000
Issue amount ($):
$488,000
Principles of Finance 6e Chapter 3
Besley/Brigham
3-7
Flotation costs (in decimal form):
7.00%
# of shares:
12,200
Other issuing expenses:
$3,840
Stock price per share:
$40.00
Underwriting fees
$34,160
Other expenses
$3,840
Total issuing costs
$38,000
Amt of usable funds
$450,000
f.
INPUT DATA:
KEY OUTPUT:
Amount needed by the firm:
$450,000
Issue amount ($):
$488,000
Flotation costs (in decimal form):
7.00%
# of shares:
15,250
Other issuing expenses:
$3,840
Stock price per share:
$32.00
Underwriting fees
$34,160
Other expenses
$3,840
Total issuing costs
$38,000
Amt of usable funds
$450,000
ETHICAL DILEMMA
Too High Tech (“Smoke and Mirrors” or Real Sales)?
Ethical dilemma:
Staci Sutter is responsible for assigning a value to the stock of ProTech Incorporated that will soon be
sold as an IPO. The financial information that Staci has been given suggests that the company is
financially strong. Although she has not been able to validate information a friend provided to her via e–
mail, Staci is concerned that the financial information she has been provided by ProTech might paint a
better financial picture than actually exists. Staci’s concern has been inflated as the result of pressure
from her boss to set a good price for the IPO. In addition, it has been reported (rumored) that Staci’s
boss is a friend (perhaps close) with the CEO of ProTech. Staci has completed her analysis based on
the information she was provided by ProTech, and she is ready to assign a price to the company’s
stock. But, if the additional, unconfirmed information she has is correct, the price she sets might differ
from what her analysis suggests. What should Staci do?
Discussion questions:
• What is the ethical dilemma?
Staci might not face an ethical dilemma. The information she received from a friend and a coworker
• Should IIBS delay the Protech’s IPO until more information can be gathered about “information”
Staci received recently?
Chapter 3 Principles of Finance 6e
Besley/Brigham
3-8
If Staci had more time to substantiate the “information” she received from her friend, she could
• What action do you think Staci, IIBS, or both should take?
As you might expect, some students will suggest that Staci ignore the additional “information,”
because it has not been validated. Ask the students what they think would happen to Staci and IIBS
if the information is correct and Staci ignores it. There is a good chance the reputation of the
References:
There is some evidence that analysts who provide earnings estimates for firms tend to overestimate,
especially if the company in question pays for the estimates. At times, companies also inflate earnings
estimates to make their operations look somewhat better than they actually are.
You can find additional information about earnings estimates in the Wall Street Journal, Forbes,
Fortunes, and other business publications, as well as various academic journals. The following articles
might be assigned for background material to provide students a better understanding of earnings
estimates provided by firms and analysts:
Susanne Craig, “As Investors Win Arbitrations, Brokerage Houses Keep Paying,” The Wall Street
Journal Online, March 17, 2004. (http://online.wsj.com/)