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Unformatted text preview: End of Chapter 16 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson April 5, 2003 Questions [See problems in book] *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Answers to End of Chapter 16 Questions 16.1. Shareholders might prefer a rights offering, since these are underpriced generally more than underwritten SEOs and have lower transactions costs. Existing shareholders might also prefer private placements, again because of the lower transactions costs associated with them. 16.2. Rights offerings are more underpriced in the U.S., making them more costly to the company. They are more used in other countries. A partial explanation may be laws requiring corporations to offer shares to existing shareholders first. Transactions costs may vary significantly between rights offerings vs. underwritten new equity issues. 16.3. The benefits of going public include: raising new capital for the company, providing publicly traded stocks that can be used in acquiring other companies, having listed stock that can be used to compensate and retain key employees and providing personal wealth and liquidity for entrepreneurs. Key drawbacks include the high financial cost of an IPO (transactions fees for doing the deal), high managerial costs (management time taken up in managing the deal rather than the core business), external pressures to maximize stock price once the firm has gone public, and required, continuing information disclosures. Important questions to ask an entrepreneur are: what are the firms need for future financing, how quickly is it growing, how reliable is his/her management team, how sound is the business model, and what are estimated revenues and costs for the company. 16.4. An investment banker determines the initial offer price through discounted cash flow analysis looking at revenue, cost and investment projections for the company, then determining an appropriate discount rate and finally discounting the cash flows, to determine firm value. Debt is subtracted, leaving a value for the firms equity. An investment banker is also likely to look at comparable firms and find a value for their client, based on multiples of comparable firms, such as price/earnings, price/cash flow, price/revenues, etc. 16.5. Significantly positive short run and negative long run returns are not consistent with market efficiency. The short run returns may be an indication of the higher risk of IPOs it is difficult to set an accurate price for a new company. Since the investment bank is unsure about price and ability to sell the issue, it may set a lower price to increase its return and reduce its risk of being left with unsold shares. Positive short run returns and negative long run returns are indicative of investor over enthusiasm for IPOs at the time of offering. There is mispricing, and informed investors can potentially take advantage of this.investors can potentially take advantage of this....
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