20: Chapter Issuing Securities to the Public
20.1 Rights offerings are cheaper than general cash offers. Even so, most new equity issues in the U.S. are underwritten general cash offers. In Canada, the bought deal is cheaper, probably due to the savings available through POP and concentrated selling efforts. In general, the ex-rights price is P = (Market value + Proceeds from offering) / Total number of shares P = ($25 x 100,000 + $18 x 10,000) / (100,000 + 10,000) = $24.36 The value of a right is the difference between the rights-on price of the stock and the ex-rights price of the stock. The value of a right is $0.64 (=$25 - $24.36). Alternative solution: The value of a right can also be computed as: (Ex-rights price - Subscription price) / Number of rights required to buy a share of stock Value of a right = ($24.36 - $18) / 10 = $0.64 c. The market value of the firm after the issue is the number of shares times the ex-rights price. Value = 110,000 x $24.36 $2,680,000 (Note that the exact ex-rights price is $24.3636.) The most important reason to offer rights is to reduce issuance costs. Also, rights offerings do not dilute ownership and they provide shareholders with more flexibility. Shareholders can either exercise or sell their rights. The value of a right = $50 - $45 = $5 The number of new shares = $10,000,000 / $25 = 400,000 The number of rights / share = ($45 - $25) / $5 = 4 The number of old shares = 400,000 x 4 = 1,600,000 a. b. c. d. 20.5 Max = $25, Min = anything> $0 50,000,000/15 = 3,333,333 shares 32,000,000/3,333,333 = 9.6 rights Me = [25 (9.6) + 15] / 10.6 = $24.06 Ro = 25 24.06 = $0.94 After: 100 (24.06) + 100 (0.94) = $2,500 Before: 100 (25) = $2,500
20.2 b..
a..
d.
20.3
20.4
Number of new shares = $40,000,000/S N = 10,000,000/ (40,000,000/S) = .25S Ro = Mo Me = 40 30 = $10 Ro = (Mo S) / (N+1) $10 = (40 S) / (.25S + 1) S = (40 10) / 3.5 = $8.57 Assume you hold four shares of the companys stock. The value of your holdings before you exercise your rights is 4 x $45 = $180. When you exercise, you must remit the four rights you receive for owning four shares, and ten dollars. You have increased your
B-60
20.6 a.
Answers to End-of-Chapter Problems
equity investment by $10. The value of your holdings is $180 + $10 = $190. After exercise, you own five shares of stock. Thus, the price per share of your stock is $190 / 5 = $38.00. b. c. The value of a right is the difference between the rights-on price of the stock and the exrights price of the stock. The value of a right is $7.00 (=$45 - $38.00). The price drop will occur on the ex-rights date. Although the ex-rights date is neither the expiration date nor the date on which the rights are first exercisable, it is the day that the price will drop. If you purchase the stock before the ex-rights date, you will receive the rights. If you purchase the stock on or after the ex-rights date, you will not receive the rights. Since rights have value, the stockholder receiving the rights must pay for them. The stock price drop on the ex-rights day is similar to the stock price drop on an ex-dividend day. Stock price (ex-right) = (15+2) / (1+0.5) = $11.33 Subscription price = 2 / 0.5 = $4 Rights price = 15-11.33 = $3.67 = (11.33 4) / 2 = $3.67 Stock price (ex-right) = (15+2) / (1+0.25) = $13.60 Subscription price = 2 / 0.25 = $8 Rights price = 15-13.60 = $1.40 = (13.60 - 8) / 4 = $1.40 The stockholders wealth is the same between the two arrangements.
20.7 a.
b.
c. general, 20.8
In the new price per share after the offering is: P i. market value proceeds from offering total number of shares At $40: P
$800,000 ($40 x 5,000) $40 25,000 Note that the new value is unchanged, because the new shares were offered at the current value. At $20: P At $10: P $800,000 ($20 x 5,000) $36.00 25,000 $800,000 ($10 x 5,000) $34 25,000
ii. iii. 20.9
There are two possible reasons for stock price drops on the announcement of a new equity issue: i. Management may attempt to issue new shares of stock when the stock is over-valued, that is, the intrinsic value is lower than the market price. The price drop is the result of the downward adjustment of the overvaluation.
B-61
Answers to End-of-Chapter Problems
ii.
With the increase of financial distress possibility, the firm is more likely to raise capital through equity than debt. The market price drops because it interprets the equity issue announcement as bad news. The costs of new issues include underwriters spread, direct and indirect expenses, negative abnormal returns associated with the equity offer announcement, under-pricing, and greenshoe option. The POP, introduced by the OSC in 1983, is a streamlined reporting and registration system for large companies that issue securities regularly. Because the OSC has an extensive file of information on these companies, only a short prospectus is required when securities are issued. IPOs are not always underpriced. Your ability to make money is directly related to your ability to purchase only the IPOs that are underpriced. If you receive 100 of each, then profit = (1,00) (1) (1,00) (.5) = $50 Expected profit = 50 (1) 1,00 (.5) =$0 This is the winners curse. The proceeds from IPO are used to: i. exchange inside equity ownership for outside equity ownership ii. finance the present and future operations of the IPO firms. Basic empirical regularities in IPOs include: i. underpricing of the offer price, ii. best-efforts offerings are generally used for small IPOs and firm-commitment offerings are generally used for large IPOs, iii. the underwriter price stabilization of the after market and, iv. that issuing costs are higher in negotiated deals than in competitive ones. The poor performance result should not surprise the professor. Since he subscribed to every initial public offering, he was bound to get fewer superior performers and more poor performers. Financial analysts studied the companies and separated the bad prospects from the good ones. The analysts invested in only the good prospects. These issues became oversubscribed. Since these good prospects were oversubscribed, the professor received a limited amount of stock from them. The poor prospects were probably under-subscribed, so he received as much of their stock as he desired. The result was that his performance was below average because the weight on the poor performers in his portfolio was greater than the weight on the superior performers. This result is called the winners curse. The professor won the shares, but his bane was that the shares he won were poor performers. a. b. The price will probably go up because IPOs are generally underpriced. This is especially true for smaller issues such as this one. It is probably safe to assume that they are having trouble moving the issue, and it is likely that the issue is not substantially underpriced.
20.10
20.11
20.12 20.13
20.14
20.15
20.16
20.17
Answers to End-of-Chapter Problems
B-62