CHAPTER 15 RAISING CAPITALAnswers to Concepts Review and Critical Thinking Questions 1.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 small. 2.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. 3.They are riskier and harder to market from an investment bank’s perspective. 4.Yields on comparable bonds can usually be readily observed, so pricing a bond issue accurately is much less difficult. 5.It is clear that the stock was sold too cheaply, so Eyetech had reason to be unhappy. 6.No, but, in fairness, pricing the stock in such a situation is extremely difficult. 7.It’s an important factor. Only 6.5 million of the shares were underpriced. The other 32 million were, in effect, priced completely correctly. 8.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. 9.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. 10.a.The price will probably go up because IPOs are generally underpriced. This is especially true for smaller issues such as this one. b.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.
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