chap019 - Chapter 19 Issuing Equity Securities to the...

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Unformatted text preview: Chapter 19: Issuing Equity Securities to the Public 19.1 a. b. c. d. e. f. g. A general cash offer is a public issue of a security that is sold to all interested investors. A general cash offer is not restricted to current stockholders. A rights offer is an issuance that gives the current stockholders the opportunity to maintain a proportionate ownership of the company. The shares are offered to the current shareholders before they are offered to the general public. A registration statement is the filing with the SEC, which discloses all pertinent information concerning the corporation that wants to make a public offering. A prospectus is the legal document that must be given to every investor who contemplates purchasing registered securities in a public offering. The prospectus describes the details of the company and the particular issue. An initial public offering (IPO) is the original sale of a company's securities to the public. An IPO is also called an unseasoned issue. A seasoned new issue is a new issue of stock after the company's securities have previously been publicly traded. Shelf registration is an SEC procedure, which allows a firm to file a master registration statement summarizing the planned financing for a two year period. The firm files short forms whenever it wishes to sell any of the approved master registration securities during the two year period. The Securities Exchange Act of 1933 regulates the trading of new, unseasoned securities. The Securities Exchange Act of 1934 regulates the trading of seasoned securities. This act regulates trading in what is called the secondary market. 19.2 a. b. 19.3 Competitive offer and negotiated offer are two methods to select investment bankers for underwriting. Under the competitive offers, the issuing firm can award its securities to the underwriter with the highest bid, which in turn implies the lowest cost. On the other hand, in negotiated deals, underwriter gains much information about the issuing firm through negotiation, which helps increase the possibility of a successful offering. 19.4 a. b. c. d. Firm commitment underwriting is an underwriting in which an investment banking firm commits to buy the entire issue. It will then sell the shares to the public. The investment banking firm assumes all financial responsibility for any unsold shares. A syndicate is a group of investment banking companies that agree to cooperate in a joint venture to underwrite an offering of securities. The spread is the difference between the underwriter's buying price and the offering price. The spread is a fee for the services of the underwriting syndicate. Best efforts underwriting is an offering in which the underwriter agrees to distribute as much of the offering as possible. Any unsold portions of the offering are returned to the issuing firm. The risk in a firm commitment underwriting is borne by the underwriter(s). The syndicate agrees to purchase all of an offering. Then they sell as much of it as possible. Any unsold shares remain the responsibility of the underwriter(s). The risk that the security's price may become unfavorable also lies with the underwriter(s). 19.5 a. Answers to End-of-Chapter Problems B-179 b. The issuing firm bears the risk in a best efforts underwriting. The underwriter(s) agrees to make its best effort to sell the securities for the firm. Any unsold securities are the responsibility of the firm. 19.6 In general, the new price per share after the offering is: P = (market value + proceeds from offering) / total number of shares i. At $40 P = ($400,000 + ($40 x 5,000)) / 15,000 =$40 ii. At $20 P = ($400,000 + ($20 x 5,000)) / 15,000 = $33.33 iii. At $10 P = ($400,000 + ($10 x 5,000)) / 15,000 = $30 19.7 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 winner's curse. The professor "won" the shares, but his bane was that the shares he "won" were poor performers. 19.8 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 overvalued, that is, the intrinsic value is lower than the market price. The price drop is the result of the downward adjustment of the overvaluation. 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. 19.9 The costs of new issues include underwriter's spread, direct and indirect expenses, negative abnormal returns associated with the equity offer announcement, under-pricing, and greenshoe option. 19.10 a. b. c. 19.11 a. b. $12,000,000/$15 = 800,000 2,400,000/800,000 = 3 The shareholders must remit $15 and three rights for each share of new stock they wish to purchase. In general, the ex-rights price is P = (Market value + Proceeds from offering) / Total number of shares P = ($25 x 100,000 + $20 x 10,000) / (100,000 + 10,000) = $24.55 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 $0.45 (=$25 - $24.55). 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 = ($24.55 - $20) / 10 = $0.45 B-180 Answers to End-of-Chapter Problems c. d. The market value of the firm after the issue is the number of shares times the exrights price. Value = 110,000 x $24.55 $2,700,000 (Note that the exact ex-rights price is $24.5454.) 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. 19.12 The value of a right = $50 - $45 = $5 The number of new shares = $5,000,000 / $25 = 200,000 The number of rights / share = ($45 - $25) / $5 = 4 The number of old shares = 200,000 x 4 = 800,000 19.13 a. Assume you hold three shares of the company's stock. The value of your holdings before you exercise your rights is 3 x $45 = $135. When you exercise, you must remit the three rights you receive for owning three shares, and ten dollars. You have increased your equity investment by $10. The value of your holdings is $135 + $10 = $145. After exercise, you own four shares of stock. Thus, the price per share of your stock is $145 / 4 = $36.25. 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 $8.75 (=$45 - $36.25). 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) = (13+2) / (1+0.5) = $10 Subscription price = 2 / 0.5 = $4 Right's price = 13-10 = $3 = (10-4) / 2 = $3 Stock price (ex-right) = (13+2) / (1+0.25) = $12 Subscription price = 2 / 0.25 = $8 Right's price = 13-12 = $1 = (12-8) / 4 = $1 The stockholders' wealth is the same between the two arrangements. b. c. 19.14 a. b. c. 19.15 If the interest of management is to increase the wealth of the current shareholders, a rights offering may be preferable because issuing costs as a percentage of capital raised is lower for rights offerings. Management does not have to worry about underpricing because shareholders get the rights, which are worth something. Rights offerings also prevent existing shareholders from losing proportionate ownership control. Finally, whether the shareholders exercise or sell their rights, they are the only beneficiaries. 19.16 Reasons for shelf registration include: i. Flexibility in raising money only when necessary without incurring additional issuance costs. Answers to End-of-Chapter Problems B-181 ii. As Bhagat, Marr and Thompson showed, shelf registration is less costly than conventional underwritten issues. iii. Issuance of securities is greatly simplified. B-182 Answers to End-of-Chapter Problems 19.17 Suppliers of venture capital can include: i. Wealthy families / individuals. ii. Investment funds provided by a number of private partnerships and corporations. iii. Venture capital subsidiaries established by large industrial or financial corporations. iv. "Angels" in an informal venture capital market. 19.18 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. 19.19 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. Answers to End-of-Chapter Problems B-183 ...
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This note was uploaded on 05/07/2010 for the course FIN 302 taught by Professor Corporationfinance during the Spring '10 term at Uni Potsdam.

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