Answers to Concepts Review and Critical Thinking Questions
A company’s internally generated cash flow provides a source of equity financing. For a profitable
company, outside equity may never be needed. Debt issues are larger because large companies have
the greatest access to public debt markets (small companies tend to borrow more from private
lenders). Equity issuers are frequently small companies going public; such issues are often quite
From the previous question, economies of scale are part of the answer. Beyond this, debt issues are
simply easier and less risky to sell from an investment bank’s perspective. The two main reasons are
that very large amounts of debt securities can be sold to a relatively small number of buyers,
particularly large institutional buyers such as pension funds and insurance companies, and debt
securities are much easier to price.
They are riskier and harder to market from an investment bank’s perspective.
Yields on comparable bonds can usually be readily observed, so pricing a bond issue accurately is
much less difficult.
It is clear that the stock was sold too cheaply, so Netscape had reason to be unhappy.
No, but, in fairness, pricing the stock in such a situation is extremely difficult.
It’s an important factor. Only 5 million of the shares were underpriced. The other 38 million were, in
effect, priced completely correctly.
The evidence suggests that a non-underwritten rights offering might be substantially cheaper than a
cash offer. However, such offerings are rare, and there may be hidden costs or other factors not yet
identified or well understood by researchers.
He could have done worse since his access to the oversubscribed and, presumably, underpriced issues
was restricted while the bulk of his funds were allocated to stocks from the undersubscribed and, quite
possibly, overpriced issues.
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.
The new market value will be the current shares outstanding times the stock price plus the rights
offered times the rights price, so:
New market value = 350,000($85) + 70,000($70) = $34,650,000
The number of rights associated with the old shares is the number of shares outstanding divided
by the rights offered, so:
Number of rights needed = 350,000 old shares/70,000 new shares = 5 rights per new share